On the Industrial Revolution


Sometime around the 18th or 19th century, people in Europe began to notice that their way of life had changed dramatically since the beginnings of the 18th century; from a subsistence economy–a world of scarcity–to a world of abundance, brought about by an explosion of industrial productivity and innovations. Some observers called that amazing ‘change’ the Industrial Revolution; others, even to this day, deny it the character of ‘revolutionary’–changes happened rather slowly, they claim. Nevertheless, whatever happened, that ‘change’ was the most transcendental event in the history of our civilization–greater than the religious Reformation, the discovery of America, or any of the other ‘revolutions’ such as the scientific, or the agrarian, or even the modern information revolution. But even to this day, there is no clear understanding, let alone a clear explanation, of such momentous event.

Whatever caused the transition from the pre-industrial to the industrial age, initially in England, was not a sudden increase in industrial production that eventually tapered off into slower growth; what changed in the early 18th century was the slope in the growth rate of the British economy; from the almost zero growth rate to a continuous growth rate of a few percent per year. That would explain the apparent paradox of a change that occurs rather suddenly, but whose effects take over a century to be felt.

Once we know the right question to ask, the answer is almost obvious. What caused the new regime of continuous economic growth? First, we need to understand the meaning of economic growth; economic growth is simply an increase in the total income of the nation, which must necessarily require a corresponding increase in the amount of circulating money.

Therefore, the answer to our original question ‘What caused the Industrial Revolution?’ is quite clear: a gradual and continuous expansion of the flow of money in the British economy, which soon propagated to the other countries of the Western World, and then to the rest of the planet. And what could have started such continuous expansion of the flow of money? The ‘invention’ of fractional reserve banking by the Bank of England in 1694.

Countries outside the Western Hemisphere are now trying, with varying degrees of success, to undergo their own industrial revolution–except for Japan, which already is an industrial country; those that are succeeding, have found a way to expand their monetary flow–usually by having a positive account balance; while those left behind, are caught up in a vicious circle of insufficient exports and excessive debt. Too bad our ‘received wisdom’ is of little help to them, or to us for that matter.

Banks and the Industrial Revolution

Economic development is nothing less, and nothing more, than an industrial revolution: it constitutes a break in the trend of stagnant or slow-growth economies. If one were to understand the Industrial Revolution, the first such break ever, one would be in the position to prescribe the necessary steps for economic development anywhere on Earth. The understanding of the Industrial Revolution is therefore crucial to any attempt at economic development.

I can only imagine that that was precisely the first thought of each of the economists—development economists—who have ever tackled the problem of development. But since that understanding was not available, they had to more or less ‘wing it’, with rather unsuccessful results.

But, what does industrial development have to do with money?—the main subject of this book—It does plenty. I am convinced that industrial development, or indeed economic growth in general, is driven by a sustained increase in the availability of money.

The major causes of the Industrial Revolution that began in England, around the beginning of the 18th century, are the ones that have been ignored by most economists and economic historians: the emergence of fractional reserve banking and of paper currency. This hypothesis, which I am presenting here for the first time, would be eventually expanded into a book-long exposition, backed by a thorough collection of facts and counter facts. However, I believe it is important enough for the understanding of economic development, and of the nature of the economy, that it needed to be included even in its present abbreviated form in this book.

A theoretical proof of such a hypothesis requires one to show that:

1.  Any increase in economic activity must be preceded by an increase in the money stock.

2.    A sustained and simultaneous increase in the stock of money could only have taken place with a fractional reserve banking system in place.

The first statement is, I believe, quite obvious. Economies slow down whenever the circulation of money is restricted; and quicken whenever money becomes plentiful. The second statement is equally obvious, at least for one who knows how banks create proxy-money. Neither of these two statements has been demonstrated in a rigorous fashion; but they are consistent with each other and with economic reality. They are also not contradicted by most of the existing economic theories.

The circumstantial proof relies on the fact that fractional reserve banking developed as such in England and Scotland ahead of the rest of the world. And that it occurred together with the expansion of trade surpluses, which provided the monetary bases for the expansion of credit. Additional evidence along these lines is provided by the emerging economies, especially in Asia, where export surplus provides the backing for the expansion of bank credit that sustains economic growth.

Other explanations for why the industrial revolution occurred in England, and not elsewhere, have been put forward by many writers. Most, if not all of those explanations, focus on some feature or combination of features that seems unique to the England of that period, thus making the industrial revolution a once-in-a-millennium occurrence. For example, the most recent one [Clark] claims that the people of England had developed, because of its singular history, and through evolutionary pressure, a gene pool with the right combination of ethics, institutions, and skills that found expression in a more vibrant and fast-growing economy. Of course, Max Weber made a similar claim over a century ago [Weber], which has been largely discredited.

Mr. Clark claims that throughout the years 1250-1800, “…the richest men had twice as many surviving children at death as the poorest… [the latter] had so few surviving children that their families were dying out” Therefore, by 1800 the culture of the rich had become the popular culture. Ordinary people had the drive and discipline, and perhaps even the genes, needed to succeed in creating and furthering the emerging Industrial Revolution. The fertility advantage of the British upper class was for many reasons not replicated in other places such as China and Japan; which explains, according to Mr. Clark, why they did not experience similar economic and technological development.

What Mr. Clark does not mention in his book, probably because it did not fit into his hypothesis, is that even before the 18th century there were several instances of localized economic prosperity. The renaissance that began in several Italian cities in the 14th century was clearly due to the very profitable expansion of trade, between Europe and Asia, through the Middle East. That trade brought gold from abroad and into the Italian banks, notably the Medici bank, which activated the economy of Florence and of the other nation-cities surrounding it.

Not being a sociologist, I am rather reluctant to advance an opinion about the relationship between culture and capitalism, but after reading Jane Jacobs (in Systems of Survival, 1992), I am convinced that Mr. Clark has it all wrong; it is the economic arrangement that determines people’s culture, and not the other way around. Just think about the class distinctions in any modern society; the middle class culture, traditions, beliefs, etc., are in sharp contrast with those of the poor, and even with those of the rich: it is amazing what a difference in income can produce.

Ms. Jacobs put forth the idea that moral principles—the cultural bases of society—evolve from the way people make their living, and not the other way around. In a market economy, people’s moral principles are aligned with those that make economic activity viable. She goes even further. She proposes that in any society there are two different, complementary sets of moral principles: one characterized by the pursuit of wealth, and the other by the pursuit of honor. She labels them ‘commercial’ and ‘guardian’ cultures, respectively. It would seem plausible that the commercial culture dominates in the industrial countries, while the guardian one is paramount in the poor countries.

Be this as it may, there can be no doubt that economic growth is by necessity associated with a corresponding increase in the money supply. Which of the two comes first—not unlike the chicken-and-egg problem—is certainly the question at the heart of the mystery.

The discovery of America brought relatively large amounts of silver and gold to Europe. That enormous expansion of wealth contributed to the expansion of trade and eventually of industry; but it also fueled large-scale wars of succession that only ended with the 17th century. The great revival of rational thought that started in the 17th century, a period known as the Enlightenment, prepared the ground for the industrial revolution, but did not initiate, could not have initiated, the Industrial Revolution: the increase in the stock of money was relatively short lived—it was in ascendancy for less than half a century, before tapering off—and it never initiated a sustained increase in credit.

There are still some naysayers who scoff at the idea of a rapid growth of industrial production occurring in a localized spot on the planet; or that such a phenomenon ever happened at all. I believe that they are dead wrong. The continuous growth of personal income, which is now a common feature of most economies, was certainly nonexistent before the 18th century. In fact, the rise in personal income must have come long after the start of the changes, for the first effect of economic growth must have been a growing population, freed from what Mr. Clark calls the ‘Malthusian trap’.

Whenever the Industrial Revolution started, it has to have broken the old trend of very slow linear growth, and initiated the new trend of geometric growth. The intersection of these two trends (or the break in the overall trend) occurred at a well-localized time in history; and that particular time is what we understand as the onset of the Industrial Revolution.

Many other trends correlate well with that of economic growth. Population size and number of innovations are two rather well-known examples. Others somewhat harder to track back are the total power usage, the number of titles published, the number of manufacture employees, the number of bank offices, the size of the money supply, etc. All these trends will show a noticeable break around the mid 18th century.

All previous explanations for the industrial revolution are sociological, geographical, and circumstantial, when not technological, in nature. It happened in England, or around it, because of certain particular historical circumstances such as a period of peace, democratic government, the scientific revolution, its physical isolation, its naval power, specific inventions, cultural and moral evolution, the protestant ethic, the gold that its corsair ships seized from Spain, its large and growing trade surplus, etc. Only the last two items come close to what I believe was the primary cause: the expansion of credit, or of the money supply, brought about by the invention of fractional reserve banking.

Gold influx alone is ineffective in creating an industrial revolution, as the 16th century experiences in Spain and in Portugal have shown. And the same can be said about trade surpluses; for instance the oil producer countries, Saudi Arabia, Iran, Venezuela, Kuwait, Russia, etc., may even be called wealthy, but they are far from being industrial countries.

The development of paper money and modern banking (fractional reserve), which started around the same period in England and Scotland (now forming the United Kingdom), correlates well with the industrialization of those regions, well ahead of their neighbors, and of the rest of the world.

Before the 17th century, money was made out of silver and gold. The types of banks that existed then were set up to lend only the money deposited, thus the total amount of money available in those economies did not change much, except through the discovery of new mines, or through foreign trade—and through conquest.

Trade certainly explains the emergence and development of the ancient empires, beginning with those in Mesopotamia and the Hellenic empires; while conquest explains the rise, as well as the fall, of the Persian and the Roman Empires. Spain and Portugal are exceptional cases; both made small fortunes starting with very large ones.

Even now, in the 21st century, wherever gold has been replaced by international currency (dollar, euro, yen, etc.), foreign trade surplus leads to monetary expansion, which leads to prosperity, as the cases of newly industrialized countries (Korea, China, India, and Brazil) and of the resource-rich countries (OPEC members, Russia, Canada, and Australia) demonstrate. Argentina is the exception that ‘proves’ the rule.

The fact that industrial revolutions, as defined above, continue to break out in a growing number of countries to this day, is the best proof that the causes of such phenomena are unrelated to the one-time-only historical coincidences discovered by previous researchers. All instances of industrial revolutions have been, and continue to be, initiated by the controlled expansion of money. And all the countries where there is scarcity of credit are poor or struggling economically.

It does not take much analysis to conclude that it is an economic impossibility for growth to take place without a previous and corresponding increase in the stock of money. Unfortunately, circulating money everywhere is proxy-money, banks’ IOUs in effect, which only enters into circulation accompanied by an equivalent amount of debt. Neither banks nor governments have much control over the stock of money. As a consequence, the financial system that exists in all countries is a very fragile structure built upon mountains of proxy-money, backed by a tiny amount of official currency. The wonder is not that every few years the financial structure is shaken, but that those episodes are not much more frequent and destructive.

The theory of freed money, if judiciously applied, can bring industrial revolutions to the poor countries of the world; and meaningful financial reforms to the rest.

A Witness to the Revolution

The final piece of evidence presented here, is in the words of a most credible witness, none other than the Father of Economics, Adam Smith. In page 378 of his magnum opus, he states:

“I have heard it asserted, that the trade of the city of Glasgow, doubled in about fifteen years after the first erection of the banks there; and that the trade of Scotland has more than quadrupled since the first erection of the two public banks at Edinburgh…Whether the trade, either in Scotland in general, or of the city of Glasgow in particular, has really increased in so great a proportion, during so short a period, I do not pretend to know… That the trade and industry in Scotland, however, have increased very considerably during this period, and that the banks have contributed a good deal to this increase, cannot be doubted.” [Smith]


The Industrial Revolution is defined by a break in the trend of slow linear growth in the pace of economic activity—prevalent since the beginning of civilization—to the rapid geometric growth characteristic of modern industrializing economies.

The hypothesis advanced here is that the Industrial Revolution was caused by the emergence, in Great Britain, of the fractional reserve bank. That rather unnoticed revolution in monetary technology allowed for a sustained growth of the money stock through an equally sustained expansion of credit.

The mass-production industrial complex, the basis of our modern economy, could never have developed without the all-but-unlimited supply of credit money unleashed by fractional reserve banking. This has been proven here, to the extent that anything can be, by both theoretical arguments and historical ‘facts’ (including reliable witnesses’ testimonies).

[From Appendix A in “The Coming Age of Freed Money” 2010.]

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