I've come to suspect that most people of modern society have only a very facile and general (surface) understanding of what "money" is.
After spending much time throughout my life studying and learning as much as I can about monetary systems, mostly as a hobby and a bit as a utility for my own life, whenever that topic presented itself I found myself paying close attention and absorbing as much as I could. I harvested ideas and info from strangers, acquaintances, friends, books and publications, economic 'experts' and professionals of our society, from talks and presentations on video, and even from the flood of opinions, threads, and diatribe from the innumerable random feeds and discussion groups on the many internet sites, etc.
As things came together in my mind, I saw there's definitely tons of good and solid information on the subject out there in the world. But I also started to see there's a whole lot of 'murky' out there too.
It's a common condition of our modern times. We seem to suffer from information overload. It seems as we acquire and pool more and more knowledge and opinion, it gets harder and harder to sort out the solid and true from the hyperbolic and false.
So what to do?
Well, maybe a lean, carefully thought out presentation of things 'monetary' would help?
My intent with this article is to provide a properly researched, clearly explained commentary about what money is and how it works in modern times, with the inclusion of a bit of back story and historical reference from time to time. Hopefully you'll walk away with further understanding of the workings and overall concept of money or at least some tidbit you didn't know or realize before.
As with most things, I always like to return to first principles...
I would suggest it starts in a similar way for all of us:
As youngsters, we are commonly exposed to this 'money' thing very early on in life. Soon our concept of it begins to form. We begin to understand it as a special type of thing that helps us get other special things we desire or need. We soon understand that to acquire money we must have it given to us as a gift or allowance, or we have to earn it by performing some sort of task or job or chore in exchange for it. Or we can sell an object or item we already possess and receive some value of cash in return for it. Sometimes we're lucky and just find it laying on a sidewalk after it presumably accidentally fell out of someone's pocket or purse. Or we discover that money can simply be stolen from someone else or from that 'cookie jar' mom keeps in the cupboard, etc.
We grow older, we probably learn a few more things about money, but often I think we tend to not explore or investigate much beyond that. This isn't too surprising. Most people, in most things, will evolve to a level of comprehension in an area or matter only to the degree they need to in order to carry out a comfortable day-to-day existence with it. It usually ends there. Further effort expends time and energy that each person may decide is better utilized doing something else. That's simply human nature.
This isn't necessarily a bad thing except that this money thing is a particular system that affects each of us more directly, greatly and personally throughout our lives than almost any other thing. We risk ending up with societies with very few people understanding it well — i.e. its origins, its evolution, its modern intricate workings or mechanics. The mass populations will go about their lives and use it daily without much thought and usually with just a surface understanding of it. And worse yet, some of these oblivious, uninformed people actually become the leaders and the shapers of our communities and economies and that directly influences and affects your personal life. Think about taxes, inflation, wages, bills.
Things tend to seem mysterious and beyond your control when you don't invest time in learning about and understanding them.
So, let's get into some of it...
Right off the line, we should recognize that "money" is a vague term.
It's more of a general term than a specific one.
Money is a social construct. A social construct is something that exists not in objective reality, but as a result of human creation and interaction. It exists because humans agree that it exists. So even though money is only a concept, idea, invention, or belief, we have all agreed to accept and trust it's validity. We've come to recognize it as a tool that makes our lives a little easier and more comfortable within our social structure.
Think about arithmetic or numbers or even 'civil law and order'. These are simply social constructs as well. In a healthy, properly functioning society if we have sound social constructs with logical and positive purposes they tend serve us well in day-to-day flourishing and well-being.
Technically, anything can serve as money. And historically, many things have served as 'money'.
Unfortunately, the exact historical details of the evolution of 'money' are lost in time even though it most certainly existed previous to any recorded records or historical accounts. In fact, naturalists like Diane Fossey and Jane Goodall have discovered and observed forms of 'monetary systems' in apes (gorillas and chimpanzees). These apes, though considered to not have yet evolved to our level of ability to perceive mental ideas and concepts, commonly exchange sexual favors amongst themselves in exchange for protection, grooming, and other 'bonds'. This may arguably be a loose definition of a monetary exchange but, none the less, it is certainly a negotiation; an exchange of things considered valuable to them and as such is at least a subset definition.
I used the word 'bond'.
'Bond' is an interesting word, considering the context of its social origins.
It's a transaction of sorts, even a subtle social ledger of 'favors given' vs. 'favors owed', 'loyalty given' vs. 'loyalty owed'. The word implies a mutual agreement of providing a thing, either immediately or in future, in exchange for something else received. A commitment. A being feels bound to reciprocating a favor with something in close approximation of value, to another being, after initially receiving something of perceived value from them.
Primitive human societies mainly used commodities valuable to them as forms of 'pseudo-money' in their exchanges and with certain attention paid to the type of social bond it created in each instance of sharing or trading, beyond the simple material benefit. This particular mindset and social interaction increased the tendency of interlinking the participants from simple families into tribal groups consisting of close relatives and/or familiar acquaintances living in a local vicinity. Eventually this economic activity expanded outwardly from very local tribal clusters to even further cooperation (trade and sharing) with other similar nearby tribal villages. This universal human practice accounts for the multitude of co-operating communities we have discovered from worldwide archeological studies and suggests it occurred frequently in a great many areas throughout the world, all with the goal of simply greater well-being and easier, more comfortable survival for all using this type of rudimentary commerce.
It appears that positive results from the interactions
resulted in trust, more bonding, and increased efforts to sustain and grow this
particular economic/social system even more.
Interestingly, even though it's obvious that our modern forms of 'money' have evolved to become so much more complex, sophisticated, and institutionalized than that, money's original intent and reason to be created remains much the same — simply personal well-being and flourishing. As I've always contended, it would seem there isn't much that is 'new' in this world, there are only new, vertical forms of it.
Anyway, to continue on with regards to these early monetary transactions, it is best to think of 'money' as being the social tool with which we primarily exchange goods and services. I'll show that money is more than merely a medium of exchange, but it's important to keep in mind its primary purpose for existence and most prominent use, that of a tool used in exchanges of goods and services.
But, hold on...
Before we start getting too deep into the weeds, let's step back a little bit, to a time just before the concept of 'money' solidified in human thinking.
I suspect that by just reading what I have written so far about the various reciprocal interactions between beings, you may have had the idea of 'barter' pop up in your mind.
Before coinage or cash (or the perception of a
monetary unit), there was 'barter'.
Barter is a process of bargaining to reach a mutually agreeable or acceptable exchange of particular goods and/or services between two people so that each party goes away satisfied with their receipts of the transaction.
In bartering, the items or services of the
transaction hold their own intrinsic value.
A cow is valuable in itself for what it can give to the one who has it, with milk, hooves & horns, meat or hide.
A knife is valuable for its utility to the owner and what they can achieve with its use or maybe just the symbol of protection it represented in earlier times if you walked around with it strapped to your belt. If it is made of finer steel and better built than other knives, it might hold even more value to the owner because it will last longer, stay sharp longer, or work even better functionally, etc.
Or a person might be very quick and nimble and skilled at running after and catching prairie chickens when no one else can do it as well. In turn these chickens, or the service of catching them for someone else, can be exchanged for things that the runner might need or want. That athletic skill has an intrinsic value unmatched in that community and has a marketable worth in itself.
So during the 'barter days', goods were produced by those who were good at a particular thing, and their surpluses were exchanged for other, different surplus products of others. And, as I've already said, some people may not have produced goods at all but were simply good at certain services or tasks that others were not able to or unwilling to perform and this became the thing that they could offer in exchange for something else, i.e. cleaning out the other person's sewage septic tank by their house or the sooty chimney.
Every product and service naturally and quickly evolved to a certain position of value in the community with a barter price-level in relation to all other products and services. And, of course, perceived values would vary from person to person towards the same things due to a particular person's needs and wants at any given time.
The important point of it all is that with the barter system, every person endeavored to achieve a personal 'gain' or 'break-even' by exchanging something they needed less for a product or service they needed or wanted more. The market economy became a latticework of mutually beneficial exchanges and was the foundational and practical system that families, tribes, groups, and societies used from the beginning and for a long, long time.
In barter, there were severe limitations on the scope of exchange and therefore on overall economic production.
So in the first place, in order to buy something they wanted, each person had to find a seller/trader who wanted precisely what they had available in exchange. In short, if an egg dealer wanted to buy a pair of shoes, he had to find a shoemaker who wanted, at that very moment, to exchange eggs for shoes. But suppose the local shoemaker was already good on the egg thing. Now how was the egg dealer going to buy a pair of shoes? How likely was it for him to just wander further from home and come across a different shoemaker who happened to need and want eggs at that time?
Or, to put the question in starker terms, suppose a person made a living as a professor of philosophy in a college somewhere. If they wanted to go out and buy a newspaper in a world of barter, they would have to wander around and find a newspaper dealer who wanted to hear, say, a 10-minute philosophy lecture in exchange for a single daily newspaper? Knowing how un-stimulating most common street-level and even more advanced modern philosophers are, I really wonder how likely it would be to find a newspaper dealer interested in such a trade?
The primary element of barter is what I call 'a double coincidence of wants'. It is the crucial thing needed to make the 'barter-engine' work. We must want what the other has to offer in exchange for something of close value that they want from us, or there is no transaction.
A second problem is one of indivisibilities.
We can see clearly how exchangers could adjust the quantities of their sales or trades of butter, cabbage, eggs, fish, or beef fairly precisely. Those items can always be sub-divided to a large extent by cutting them into smaller pieces or dividing a larger grouping of eggs into many sub-groups. But suppose that Mrs. Jones owns a house, would like to get rid of it and instead get a car, a washing machine, and some horses? How could she do so? A house is worth a lot. Each of the things she desires aren't worth as much. She could not simply chop her house into 20 different segments and exchange each one for other products. Clearly, since houses are indivisible and, more importantly, lose most or all of their value if they get chopped up, we come up against an insoluble problem. The same would be true of tractors, machines, farm wagons, and other large-sized products.
And a more dire quirk of the economics, relevant to this situation, immediately arises: If houses are not easily bartered, then not as many will be produced in the first place or any other type of thing with the same restrictions on its marketability. Yes, there will be houses and large items produced for everyday ownership and use, but there will not be much beyond that. An indivisible commodity isn't an easy, practical marketable item in a barter/trade environment. So the entire economy of that particular society is stunted or shrinks. There is a restriction on growth because things that could be produced won't be, because there is less chance of them moving around economically within a barter system.
So early on, it became evident that the barter
system itself could not succeed beyond the needs of a primitive village or
small grouping of village tribes. It doesn't have the flexibility of easily
liquidizing or partitioning a large asset in order to acquire smaller assets in
For example: I may not want to butcher my cow that day just because I want a small pot of grain even though I need and want the grain. My beautiful cow simply remains in the meadow quietly grazing while I sit there hungry, skinny, bored, and sad.
So as societies grew, spread out and evolved, this became an obvious, significant problem.
Well, mankind is innovative, imaginative, and ingenious. They managed to find a way to overcome these obstacles and transcend the limiting system of barter. The solution they arrived at, the invention they came up with in a step-by-step fashion, became one of mankind’s most important and productive concepts: money.
So let's jump back again to the egg dealer who is
trying desperately to buy a pair of shoes.
He thinks to himself, "If the shoemaker doesn’t want the eggs, what does he want to trade for?" In desperation the egg man is compelled to find out what the shoemaker would like to obtain. Suppose he finds out that it’s fish. Apparently the shoemaker loves the taste of fish and would love to have a bunch of fish in his iced pantry.
So the egg dealer asks around and eventually finds out that some fishermen at the Warf like and want eggs so he makes the trip, many miles from his town, to their fishing boats. In the world of pure barter, everyone’s purchases were only for themselves or for their family or tribe’s direct use. But now, for the first time a new twist is introduced: the egg man is buying fish not for its own sake but for use as a way of obtaining shoes. Fish has suddenly become a 'medium of exchange', an instrument of indirect exchange. And the egg man is intentionally acquiring them for that direct purpose.
He brings his fish back home and then the next day totes them to the shoemaker who is excited to see them and eagerly trades a pair of shoes for them. The egg dealer got his shoes. The fishermen got their eggs. The shoemaker got his fish. All is well.
Let's create a little drama here to analogize how things probably progressed...
As it turns out, in this particular town, fish were
a bit difficult to attain and it became known that many of the other people
living there, after hearing about the deal the fish-fillet loving shoemaker
made, lamented over their wish for such a lovely feast and supply of fish as
well. Most of these rural people had their share of berries, chickens, potatoes,
carrots and small goats... but fish, they didn't have any or enough of for
Fish were scarce and hard to get. If someone figured out a way to get a hold of a bunch of fish, they could bring them back to town and trade them for other things the townsfolk had.
So the fish suddenly became a medium of exchange for goods and services in that town.
A few entrepreneurial individuals in town took notice of this lamenting and realized that if they could take their beans, their carts of coal, their cords of firewood, their buckets of honey, their milled lumber, their woven cloth, their lengths of hemp rope, etc. and journey to the Warf maybe they could negotiate with the fisherman for an equitable amount and type of fish stock.
Many traders were successful and would travel back to the town with their many baskets of fish to use for barter for whatever townspeople had to offer in exchange. Since fish were universally wanted, valued, and accepted, the people would be willing to trade almost anything they possessed for them once an agreeable transaction was agreed upon. They may have not needed coal at the time, or firewood, or rope but they certainly immediately would take fish for something they had to offer in payment.
The traders, who previously couldn't get anyone to even notice the cords of firewood they had, were now getting all sorts of wonderful things from townsfolk for the fish they provided (that they had traded all that firewood for).
Once a commodity begins to be successfully used as a medium of exchange, this usually generates even further use of the commodity as a medium. A cascade. This is a "duh" statement but in short, when the word gets around that commodity X is wanted, valued, and being accepted as a medium of exchange in a certain town or village, more people living in and/or trading with that village will seek to acquire that commodity since they know that it is being accepted there as a medium of exchange.
In this way, the popularity of the commodity feeds upon itself and its use spirals upward. Before long the commodity comes to be in general use throughout that society as a medium of exchange. And once a particular commodity was used as a 'medium' for many, most, or all exchanges, that commodity becomes a de facto form of 'money' in that society.
So, in this way the concept or idea of 'money' entered the free market. In our story, fish was money. That particular view of something quickly creates a major shift in the population's mind as to what a particular thing represents to them. This is a very important psychological adjustment. It reorients how people view something and shape its validity — level of belief in their mind. A thing like a fish isn't really a just a fish anymore, it becomes a form of money, currency, or exchange.
So back to my little story... The fish as money is fine for a while, even as everyone in that local culture figures out why it works so well as a popular medium-of-exchange and how it does so. But soon certain portions of the people began to devise ways of getting their hands on fish more easily and in cheaper ways. (There is always that particular layer of the population that seeks to find advantages or ways to gain the system).
Some realized that they could simply go to the shoreline, fish for hours, pull a bushel of fish from the water and have good value for their efforts for that day (like mining). Or on a grander scale, others figured out that they could pay a crew of people a portion of the profits to go out and fish all day and capture a much greater pile of fish each day.
Remember, these fish were not to eat but to trade for something in that community where they were valued, had become an actual medium of exchange, and up to that point were locally hard to get.
But soon, in the community, fish were starting to be everywhere because of the many business 'upstarts', each having the same idea, and the area eventually became overwhelmed and flooded with fish inventory.
The commodity becomes too familiar, fairly easy to
acquire — not as valuable or rare to people trading, buying, and selling it. The
'medium of exchange' (fish) became too common and not so precious. The
community's essential form of money had became essentially worthless. Nobody
wanted to give up something they valued for just some fish.
"Fish are everywhere! but my little pearl necklace is the only one in town!", a lady was heard to exclaim.
This, of course, is a made up story but something like this most certainly happened often in some aggregate form throughout time in many cultures. The world's discovered archeological records and artifacts certainly suggest or assert that many early cultures 'discovered', evolved and functionally invented money in a similar way.
I say again... mankind is innovative, imaginative,
This community's economy may have temporary receded or collapsed somewhat but what happened is that the marketplace simply began to realize it needed to pivot and move to more specific, rarer, harder to acquire commodities for use as a medium of exchange for goods or services. Fish hadn't worked out so well.
And, the most important thing had happened...
Money permitted people to overcome all the deficiencies and difficulties of barter. This new concept had been stumbled upon, naturally evolved, became more and more refined, and as it was practiced in countless societies worldwide the great advantages of using it solidified. A certain part of mankind's psyche and our ability to understand abstract concepts sparked and we realized we had invented (discovered) a way to make all our social interactions and lives a whole lot easier and more comfortable by extending individual well-being and flourishing. From then on, there was no turning back.
The egg dealer no longer has to seek out a shoemaker who wants eggs; a philosopher doesn't have to find a newspaper dealer or a grocer who wants to hear a lecture. All that's needed is for us to exchange our personal goods or services for 'money', in the amount of a medium-of-exchange that the market has decided and agreed the particular thing is worth. We do so in confidence and trust that we can take this universally valued 'medium of exchange' (money) and trade it for any goods or services that we may need or want (to the extent of that money's total market worth, of course).
'Money' meant that a middle aged lawyer lady didn't have to know how to make a wagon wheel. It meant that a middle aged millwright man didn't have to know how to make a pair of woolen socks. It meant a merchant didn't have to know how to play the organ for his daughter's wedding or a baker how to build a better oven she'd like to have to make more products in her bakery. A universal medium of exchange eliminated these complications and made life easier. Eventually, all you had to do was concentrate on what you were good at and accumulate enough of the 'medium-of-exchange' to eventually get from others what you needed or wanted.
And just to circle back quickly, the problem of indivisibilities in the barter system are also easily overcome. A homeowner can sell their house for money, and then exchange that money in whatever proportion they need to for the various goods and services that they wish to acquire.
So the question becomes, which commodities are
picked as money by the market?
Which commodities will be subject to a spiral of use as a medium?
Through the centuries, many commodities have been selected; fish on the Atlantic seacoast of colonial North America, beaver pelts in the early Canadian Northwest, and tobacco in the southern colonies was used; all had their stints as money. In other worldwide cultures salt, sugar, cattle, tea or spices, Cowrie shells, even iron hoes, obsidian, pieces of meteorites, and many other commodities have been known to be used in marketplaces and transactions.
Amid this variety of moneys, it is possible in each case to analyze the qualities which led the market to choose that particular thing as money.
In the first place, individuals do not pick the medium of exchange out of thin air. They will overcome the 'double coincidence of wants' of barter that I earlier alluded to by picking a commodity that becomes widespread in use for its own sake. In short, they will pick a commodity that is naturally in heavy demand, something most people universally desire to have or hold in value, something that sellers, vendors, service-people, etc. will be likely to accept in exchange from the very start for their goods and services.
Second, they will pick a commodity which is highly divisible, so that small chunks of other goods can be bought, and size of purchases and the size of the payment can be flexible. For this they need a commodity which technologically does not lose its proportional value when divided into smaller pieces. Remember that a house or a tractor, being highly indivisible, is not likely to be chosen as a common medium of exchange or money, whereas something like butter, for example, which is highly divisible and at least scores heavily as a thing that could be used as money for this particular quality.
Demand and divisibility are not the only criteria.
It is also important for people to be able to carry the money commodity around with them quite easily so they have it on hand when they come across something they wish to purchase. To be easily portable, a commodity with high value per unit-weight would be the most advantageous. It also follows that to have high value per unit-weight a good has to be not only in great demand but also relatively scarce. An intense demand combined with a relatively scarce supply will result in a high worth or high value per unit-weight.
And finally, the money commodity should be highly durable, so that it can serve as a store of value for a long time. The holder of money should not only be assured of being able to purchase other products right now, but also indefinitely into the future. It would be a shame to work very hard to finally get a store room full of fish that could be used as money but you experience a heat wave and have them decay and rot before you're able to trade them all. All that work and effort simply vanishes for you. The same thing applies to butter or eggs or even tobacco or sugar to a point — to the extent they fail on the question of durability.
So to sum up, a medium of exchange or commodity we choose as money should have these features:
· Portability (high value per unit or proportion of unit)
A fascinating example of an unexpected development of a money commodity in modern times occurred during World War II in German POW (prisoner of war) camps.
In these camps, supply of various goods available to prisoners was fixed by conditions external to them, i.e. they were allowed by the captors to receive certain small amounts and types of CARE (Co-operative for American Relief Everywhere) packages from their people back home, or extra/special rations or privileges provided time to time for good behavior and camp work done, and of course the meager provisions they were allotted each day by the captors, just to keep them alive.
After receiving whatever rations they happened to get on a given day, the prisoners began exchanging what they were willing to give up for what they happened to want or need from a fellow prisoner (all clandestine of course). Soon there was an elaborate price/value system for every product flowing through the POW camp world, each very specific and in relation to the prime money commodity that arose to be the most popular: cigarettes. In this micro economy, prices in terms of the cigarette monetary system fluctuated in accordance with the constantly changing supply and demand of both things-to-purchase and cigarettes available.
Cigarettes were clearly the most 'money like' thing available to the prisoners in the camps. They were in 1) high demand for their own sake, 2) they were somewhat divisible (or at least packs of 20 were and even individual ones in terms of a quantity of tobacco you could divide a single smoke into), they were 3) portable and at most times had high value per unit weight. However, they were not very 4) durable, since they crumpled easily or the tobacco could get accidentally soaked or contaminated somehow, but the prisoners made do for the years the camps endured.
There is more interesting history to this story but I'll leave it at this for now.
So maybe it's time to address the elephant in the room?...
In all countries and all civilizations, two commodities have coincidentally but not very surprisingly risen to be dominant whenever they were available to compete as moneys with any other commodities: they are gold and silver.
At first, in early times, gold and silver were highly prized mostly for their unusual luster and ornamental value (used mainly in jewelry and ornaments, for example, and were a commodity mostly only a rich person of societal status and power could accumulate). But whether possessed or not, these commodities have always been prized since the dawning of modern man by mostly everyone. This first point is the most important because if the demand and want for something isn't there, its purpose devolves quickly and it certainly becomes inconsiderable or inconsequential as a medium of exchange.
Second, silver and gold are relatively scarce (hence they are valuable per unit-of-weight) and for that same reason they're naturally an item of high value-per-size too and quite portable.
These commodities are also very divisible, being metals, and could be pounded, chiseled, cleaved or sliced into thin segments, small plates or cubes, each without losing their proportional value. It was discovered over time that pieces could also be combined or recombined to a larger whole by melting the metal in specially designed high heat stoves or fireplaces and the unified molten gold or silver could be poured into a mold to cool.
And over time, cultures discovered these metals could be blended with small amounts of alloy to harden them, and since they do not corrode, they would become very durable and essentially last forever (certainly beyond the immediate lifetime of people possessing them).
Thus, because gold and silver spectacularly and significantly meet all the requirements of a sound 'money like' commodity, they were/are usually selected by markets as money if they are available. Modern nostalgic proponents of the old gold standard (and silver for that matter) do not suffer from a mysterious 'gold fetish' or hysteria, or something like that, they are simply recalling and recognizing that gold was always selected by the market as money throughout human history for very fundamental, sound reasons.
Another observation is that gold and silver have both been moneys throughout the ages and were very commonly side-by-side. But since gold has always been far scarcer, and so in greater demand than silver, it has always commanded a higher price (value). Gold tends to be the money used in larger transactions because it commands greater value-per-weight, while silver has been commonly used in smaller economic exchanges.
The difficulties involved in the finding and mining of gold, which makes for limited production, also makes its higher long-term value relatively more stable than silver. Because of this higher value, gold has also often been selected as the unit-of-account (the 'golden' standard from which all other money and commodities are measured against). This status however, has not always remained universal i.e. the Spaniards in the 16th+ century with their silver stocks from the New World.
It's also important to consider, a gold coin is wonderful and nice to possess but practically speaking, a fine silver coin (silver being more easily found and more abundant in the earth) is going to be more popularly circulated and commonly known and used in a society of people that doesn't have great wealth, ability to accumulate it, and generally use most of their currency in just day-to-day living and transactions (meaning they don't tend to stock (bank) any or much of it, or for long).
So in a practical sense, the common population has always become more familiar with silver than with gold. Yet gold has still historically maintained its place as the most commonly selected unit-of-account (even though it always remained more symbolic/iconic than practical or tactile to the hoi polloi).
I mentioned the word 'price' a few paragraphs up. That wasn't intended to be off-hand.
What is a price?
A price is simply the ratio of the two quantities of equal value exchanged in any transaction. This is more complicated a statement than it first appears.
Suppose you and I are negotiating the sale of a chicken. You have a chicken, I have some silver. I don't give you the weight of silver equal to the weight of your chicken. That wouldn't be wise. But suppose the market has already determined, through countless 'chicken trades/sales' between people over time in that region, that a common chicken is worth an 1/8th of an ounce of silver to sellers, and buyers are willing to give up an 1/8th of an ounce of silver to get a bird.
So I show up and happen to have an 1/8th ounce of silver in my pocket, you have that chicken, and I want chicken for my supper. We make a deal. Two quantities have been exchanged through the medium-of-exchange of silver.
But, you say, one of those things was just a chicken and not silver. Yes and no. It was certainly a chicken but it also represented a certain weight of silver in the economy as well.
When I approached the chicken seller, that entire chicken (whatever weight, however much meat, feathers, beak, eyeballs, size, and all) already had a commonly known market value in that community that established what a common, normal chicken of that type equals in a certain weight of silver. Chicken = 1/8th ounce of silver, in this case. My actual silver doesn't require conversion ( but maybe weighed by the seller to verify) and assuming all is ok, the transaction happens and all go away happy (except maybe the chicken). I restate, essentially two equitable quantities of silver have been exchanged.
So, we need to pause here and understand that every monetary unit we have had in society and are now familiar with — the dollar, pound, mark, franc, lira, et al. — began on the market simply as names for different units-of-weight of gold or silver in the particular societies or communities they were used in. Indeed, at one time, the “pound sterling” in Britain was exactly that — one pound of sterling silver (sterling meaning genuine or authentic). The descriptive used to identify the monetary unit routinely represented a certain weight (and thus quantity) of the two most common rare commodities, gold and/or silver, in that particular region of the world.
In my chicken example above I simply stated that
1/8th ounce of silver would equal the value of that bird in that market. That's
probably not very accurate, I don't know... it was just for sake of example.
But it does bring up an important question:
What determines individual prices?
Why is the price of eggs, or horseshoes, or steel rails, or hair combs, whatever it is?
Is the market determination of prices arbitrary, or chaotic, or anarchic?
The answer is that any given price is always determined by two fundamental, underlying forces: supply and demand — the supply of that product vs. the intensity of demand to acquire it. The market price is that point where supply and demand intersect in that there is enough product in stock to acquire by those who want it and are willing to pay the price demanded for it.
More stock, especially if it's perishable goods like cartons of milk quickly approaching their 'due date', creates a condition where the seller might be willing to drop their demanded price a bit so a purchaser might be enticed to buy more of it at that lower price, as it appears to be a 'deal' to them. Conversely, if demand is high for certain goods but stock is low, the seller can ask a bit more than usual for their stock because it is more scarce. But if demand for a product drops off entirely, no amount of stock is much good to the seller (or purchaser for that matter) and can actually become a liability to the seller (and purchaser who previously acquired some, in some cases).
Since the exchange of gold or silver is by weight, the various national currency units, all defined as particular representations of weights of a precious metal, will automatically be fixed in terms of each other. So, suppose that the 'dollar' is defined as 1/20 of a gold ounce (as it was in the nineteenth century in the United States), while the 'pound sterling' (in the U.K.) is defined as 1/4 of a gold ounce, and the French 'franc' is established at 1/100 of a gold ounce. Well the exchange rates between the various currencies becomes automatically fixed by their respective representative quantities of gold.
Basing a valuation of a coin on gold did not necessarily mean the coin itself was made of any gold. It could very well be made of silver and the requisite value was simply based on the proportional value of 1 ounce of silver in that marketplace compared against 1 ounce of gold. Almost always, and typically, gold was the base standard that all other metals were measured against.
Trading between different regions of the world became a lot easier. If a dollar is 1/20 of a gold ounce, and the pound is 1/4 of a gold ounce, then the pound will automatically exchange for 5 dollars. And the pound will exchange for 25 francs and the dollar for 5 francs. In summary, the defining weights of the currencies also automatically sets the exchange rates between them.
At this point it's important to understand that the dollar is not an independent entity to gold or silver –– it originally was simply just a name given to a coin (later script) that represented a certain weight of gold, for that region of society. But I'm getting a little ahead of the story. Let's drop back a bit.
Coins were the first type of a more enduring money that appeared in this evolving market economy. Each was made from a certain amount of the rare metal gold or silver.
Now, if the monetary unit is simply a unit of weight of a precious metal, then government’s role in the area of money as an authority to keep the system in check and honest for the citizenry, could well be confined to a simple Bureau of Weights and Measures, certifying the content and weights of monetary units as well as other common units of weight, length, or mass already in use in the marketplace.
The problem is that governments always seem to grow and bloat and typically grow to gain an upper hand over the citizens of a society. Over and over they have all systematically betrayed their trust as guardians of the precisely defined weight of the representative money commodity in their areas.
When government sets itself up as the guardian of the standard 'yard' or international 'meter' or 'pound' or 'bushel', there is no economic incentive for it to betray its trusted role and change the definition. For the Bureau of Standards to announce suddenly that 1 pound is now equal to 14 instead of 16 ounces would make no sense whatever. To declare a yard was now 4 feet instead of 3 would be unnecessary and absurd. These systems evolved in society over a long time and once in common use and understanding it became the role of authorities to simply ensure everyone followed the standards and rules so there wasn't any cheating or unfair advantages.
But money is different.
Early systems of rule saw leaders who were essentially the final word on most matters in their kingdoms, empires, or dominions. They demanded taxes, fees and dues from the people for services like meting out justice, or protection from invaders, monitoring trade at the borders, or to pay for infrastructure projects that benefitted the whole society, like a canal, bridge, dike, or road. Large bureaucracies, whose jobs were just to run the affairs of the government, always formed around leaders.
Governments always become little "industries" unto themselves. They come up with important missions, devise undertakings and projects, and have many obligations to the people that keep them in power. But they are always thinking of new ways and methods to maintain and even increase their income. And like any enterprise the many people nested comfortably within the government system rely on it for employment and the lifestyle it affords them. They usually wish for it to continue and often wish to expand their power, influence and prestige even further.
Governments and leaders commonly like to present their States as successful and strong and progressive to their own people and foreigners. Often public buildings, pavilions, monuments, etc. were built that were quite impressive in architecture, location, and size. Artisans, artists, sculptures, and musicians were commonly employed and sponsored by rulers and governments to create impressive and beautiful things that were meant to lift up cultural presence and value. Conflicts and wars with neighboring States demanded the building of ships, spears, swords, maintaining, feeding, sheltering regiments of soldiers, etc. Spoils of war sometimes brought actual captured money back to the victor's coffers but when victory amounted to mostly conquering land, populations, and regions, returns on investment were not as immediate.
To put it simply, running a kingdom, State, empire, or government gets very expensive.
Thus we encounter an age old problem. Rulers and governors seemed to always be in need of more money (coinage). They kept running out of it. There is always a tendency of bloat in any governmental system. People tend to grow dissatisfied with their present state of life and always seek to better it, especially if they view fellow humans doing better than themselves. Human nature again.
There became a great incentive and temptation for governments to change, especially to lighten, the definition of the currency unit of their society — like how the original 'pound sterling' that was originally introduced in the UK marketplace, some years later, went from 16 to 14 ounces of silver (it's first devaluation). It was justified as being necessary and deemed it would be so slight a change that it wouldn't be a great shock to the economy or monetary system. The officials were, after all, the guardians of weights and measures so they assumed that right extended to money or the 'coin-of-the-realm' and that it needn't be held to a static definition.
Many coins (even to this day) have a likeness of the ruler, leader(s), or coat-of-arms of the government stamped into them. This initially wasn't to say they were 'deemed' into existence by these visages, because only the market can do that. It was more a signal or message to everyone that this coin was part of a robust, unified local economy and could be trusted. People recognized it had the backing of the power of the State at home and when trading with neighboring States.
So it's understandable that there was a certain pervasive psychological shift/leap in how citizens thought in most societies. They were exposed to coins every day and when seeing those images on them so often, deal after deal, began to think of the coins as deriving from, 'belonging' to, or at least trusting they could be rightfully 'controlled' by the ruler or government of the State. This is of course a mistake but maybe I'll get into that later on.
So changing the definition of a currency unit turns out to be a profitable process for the State. There starts to be a repeatedly lightening of the number of ounces or grams of gold or silver in the same monetary unit.
This is called debasement.
How debasement profits the State can be seen with another little drama from me:
Let's say the glick, the currency of the mythical kingdom of Glickytania, is worth 20 grams of gold. The old king dies and his son ascends to the throne as the new king.
It turns out dad had enjoyed a pretty extravagant reign and the new king discovered that by now the kingdom's treasury is quite drained, bare, and poor. So being chronically short of money, and in immediate need of it, the new king decides to take the debasement route to acquire some wealth.
He announces a mammoth call-in of all the gold coins of the realm, each now dirty and worn with use, and each with the picture of the previous king stamped on its face. In fact, the propaganda sent out was that we should refresh our coins with the new king's image and at the same time worn coins will be renewed. New times or eras merit fresh beginnings! Yay.
For the return of coins to the treasury the king said he would supply brand new coins with his face stamped on them and most importantly it would be a 'one-for-one' exchange –– the king would return the person the same number of glicks they turned in. Someone presenting 100 glicks in old coins would receive 100 glicks in the new.
This was viewed by all as a seemingly smart, logical
thing to do with no cost to the people.
Except for a slight hitch: During the course of this re-coinage, the king changes the definition of the glick from 20 to 16 grams. Each coin they melted down got re-poured with only a content of 16 grams of gold. When everyone had been paid back, one for one, there was a big pile of gold left over on the table at the treasury mint (in fact it was 20 percent of the weight of all the original coins that were re-minted).
The king had this gold also minted into new glicks and put them in his treasury. Basically, the supply of glicks within the kingdom had now increased by 20 percent and over the next while the king spent the coins into circulation for his expenses.
In short, the number of grams of gold in the society remains the same, but since people are now accustomed to use of the name of the money rather than the weight of gold in their money, it largely goes unnoticed and at first doesn't affect accounts or prices.
With the money supply in glicks having gone up by 20 percent we shall see later on, this will drive up prices in the economy in terms of glicks, as well. Debasement, then, is the arbitrary redefining and lightening of the currency with the sole purpose of adding to the coffers of the State. Since paper currency did not yet exist, kings and governors (Roman for ex.) had to be content with mostly only the debasement process and its hidden or at least subtle 'taxation' of the subjects.
In a real world example, the pound sterling has diminished from its original 16 ounces of silver to its present fractional state because of repeated debasements (changes in definition), by the kings and queens of England and later English Parliament. In fact, rapid and extensive debasement was a striking feature in basically every country, State, and kingdom in Europe during the Middle Ages. In 1200, for example, the French 'livre tournois' was defined as 98 grams of fine silver; by 1600 it equaled only 11 grams.
A particularly striking case is the dinar, the coin of the Saracens in 7th century Spain. The dinar, when first minted, consisted of 65 gold grains (grains are another form of measuring the weight of gold). The Saracens, notably sound in monetary matters understood the concept of debasement but kept the dinar’s weight relatively constant for their economy's sake. As late as the middle of the 12th century, it still equaled 60 grains. They understood that stable, dependable, trusted money drove and complimented a healthy economy.
However, at that point the Christian kings rose up and conquered Spain. There was great upheaval and change in society. Many wars, events, ventures, and activities occurred and all required much money to carry them out while everyone sought to stabilize life within these new alignments. By the early 13th century, the dinar (now renamed the maravedi) had been reduced to 14 grains of gold.
Another interesting thing happens with debasement
that should be obvious.
Simply, with further and further events of debasement, the gold coins become too lightweight to circulate. When the Spanish realized the maravedi wasn't practical anymore they decided to convert it into a silver coin weighing 26 grains of silver. Thus they once again had a maravedi that was a substantial enough coin to use in day-to-day market transactions. It retained its former diminished gold value because silver has less value per weight than gold so more is required to equal the same value in gold.
But this new maravedi was debased over the following years as well and by the mid 15th century it consisted of only 1½ silver grains and was again too small to circulate. It soon disappeared from the market place due to its impractical size and value (it experienced inflation pressures) and everyone's annoyance with it. They used other, finer and more consistent coins that found their way into the market through outside buyers and sellers.
So we've already exposed four important features that money must have to have legitimacy and longevity i.e. demand, divisibility, portability (high value per unit or proportion of unit), and durability.
But it starts to be obvious that money must also have a fifth feature — it must be a widely accepted unit of account.
This is an attribute of money that enables people to use it to measure, track, and record the value of goods and services and the progress and state of their financial transactions. It may take a physical form, like countable currency or bullion in a vault or safe, but often it is an intangible 'book-keeping' asset such as a special drawing right as in a chequing or savings account, an RSP, a title or deed, pension fund, or even an account holding only foreign currency (such as Euros) for someone living in North America.
Business and individuals need to keep track of their transactions to know where they stand economically. They need to analyze where they are making money and losing money, what transactions were successful and which ones should be avoided in the future. Accounting and book-keeping.
For this last aspect of money, it becomes important that money isn't constantly being manipulated by authorities, devaluing it through debasement, etc. Otherwise the unit-of-account system becomes chaotic and unreliable with the money's value-per-unit constantly shifting and thus the value of accounts constantly fluctuating (usually in a negative direction).
At this point I want to shift into the topic of fiat (paper) currency but before I do that, allow me to share some interesting history on the dollar that I wrote up some years ago...
The “dollar” originated as the name generally applied to a one ounce silver coin minted by a 16th century count named Schlick (yes that's a real name). The Count of Schlick lived in Sankt Joachimsthal (Joachim’s Valley) a town in the Erzgebirge Mountains in northwest Bohemia (in modern times in the Czech Republic, close to Germany). He opened a silver mine in his town, and from the ore began to mint and issue a good amount of silver coin. His coins, which enjoyed a great reputation for uniformity and fineness, were initially called "Joachimsthalers" and finally just thalers. German 'thal' is analogous with English 'dale' (valley). In the late 1500s the thaler became the cleverly contrived word daler to the English, based on the English word for valley (dale). The spelling was soon modified to 'dollar' by 1600.
Remember, in the earlier years, currency was made from actual precious metals (usually gold and silver, sometimes lesser metals like bronze, copper, nickel). The truer, purer and well-made the coin, the more valued and respected it was by people. If a coin maker kept to high standards and integrity in keeping the coinage to a precise standard of percentage of precious metal contained within it and a constant, uniform size and weight, the word got around in the markets and people tended to want, trust and value it more than other currencies and coins circulating at the time. The thaler was one of those that had risen to the top.
By the 1600s the thaler was the more-or-less standardized coin of the northern German territories and municipalities (as opposed to the southern 'gulden'). It also served as a currency unit in Denmark and Sweden (even became a unit of the German monetary union of 1857-73, equal to three marks). It was accepted in exchange throughout Europe by other countries in trading and marketing of goods and services because of its reputation and fineness.
As early as the 1580's or so, many of the British (and Dutch) and including some who would soon became colonists in America, used the word dollar to also reference the popular Spanish peso or "piece of eight" because it was such a similar looking large silver coin of about the same fineness and size of the thaler (which they already called a dollar by then). Many of the emigrants even brought some actual thalers (dollars) and Spanish pesos (the 'other' dollar) with them from old world Europe and people saw them flow through their new communities from time to time.
The initial colonists journeying to the North American Atlantic coast were primarily British. But even when they first arrived there was already an overwhelming presence of the Spanish in Central, South America, and even in the south-eastern coastal areas and south-western lands of North America (nowadays known as California, New Mexico, Texas, Arizona). The Spaniards were conducting extensive mining activities that were literally flooding the 'civilized' world economic markets with newly minted silver Spanish coinage and bullion. (It actually created an early incidence of 'global' inflation — but, a topic for later).
Anyway, the new colonies soon established 'give-and-take'
widespread trade with the nearby Spanish Indies for essentials, resources and commodities.
Due to that and the trade with the many proximate Spanish colonies along the immediate
Gulf (of Mexico) coast and Atlantic seaboard below the colonies, the Spanish 'dollar'
(actually the 'pieces-of eight' peso) quickly became the coin most commonly
used, familiar, popular and abundant in the American colonies.
It essentially became the unofficial currency standard.
Dollars soon also became well set into the everyday psyche of the colonists — it became second-nature/easy for anyone to mentally quickly calculate/measure the worth of goods and services against the value of a silver dollar. Francs and English pounds were also fine but there was a certain conversion (translation) you had to do in your head before you could understand and realize the economy of the transaction as quickly.
Well, many decades passed, and eventually by the late 18th century the American revolution came about. There was a huge shift in colonial sentiment towards directly rejecting anything British, including British money and their pound sterling. Therefore the 'dollar' became even more populist, revered and dominant. To American colonists, pounds were "the enemy's" money, dollars were "our" money. In fact the dollar had even become the default currency used within the formal records and bookkeeping of public debt and expenditures throughout the colonies.
Finally, after victory a few years later, the 1786 Continental Congress formally adopted the 'dollar' as the new American standard monetary unit and set up the modern US currency system around it (although no actual 'American' dollars were yet produced and circulated until 1794).
But following this, foreign coins of gold and silver continued to circulate freely throughout the new USA (as they did in virtually all other countries in the world), and indeed there is no reason why they shouldn't do so. Money is, after all, an economic process and should not be political. In fact, in the US as late as 1857 many didn't bother going to the US Mint to obtain coins. The coins in general use in the marketplace were Spanish (which Americans still equated to equal a dollar), English, and Austrian gold and silver pieces, but of course many US coins as well. But finally, the members of Congress became perturbed at this perceived slap to sovereignty and passed a law that outlawed the use of foreign coins within the US, forcing all foreign coin holders to go to the US Mint and obtain American gold coins in their stead or risk not being able to do business.
As an aside, the dollar sign ($) is said to derive from the image of the Pillars of Hercules, stamped with an overlaid scroll on the Spanish peso (piece-of-eight coins). Other theories suggest the Spanish "P" for pesos, or piastres (meaning pieces of eight) stamped on the popular silver coin also had an "S" stamped over the P to distinguish them as Spanish derived coins (as opposed to certain Mexican derived coins which were suspect of having less silver content) thus creating a close equivalent of the "$" mark when viewed.
Regardless of any origins lost to time, the symbol became widely and commonly used to represent the dollar and was formally recognized with the creation of the United States dollar in 1786.
An interesting side note:
The original Spanish 'piastres' silver coins that were used everywhere in the early colonies had actual creases, cleaves (dents) pressed into them when they were minted, so the coin itself could be twisted, flexed and broken into pieces (8 pieces actually - hence the knick-name "pieces-of-eight").
Each piece (division) of this Spanish coin ("peso" was the coin's formal name and "dollar" was the colloquial name) was called a 'bit' by the Americans. Picture an original silver coin that is perfectly whole and circular but is also perfectly divided by creases pressed into the coin's metal, forming 8 little pieces of 'pizza slices' (to help you with the visual).
It was a clever system design that evolved so that far away from "civilization", where money denominations were scarce and hard to get, a person could pay less than a full coin to a seller or employee for things that weren't worth that much by breaking a piece or two (a bit) from the silver coin for payment.
For example, a buyer and seller would agree the 3 chickens and a bread loaf were worth one bit. The buyer would bend and flex her silver dollar back and forth until she separated a bit (1/8th) from it. The buyer could then walk away with her purchases and the seller had the satisfaction of being paid enough "coin" (real silver) for his product.
In those earliest days, it wasn't uncommon for a person to have a collection of pizza shaped bits of silver in his pockets along with whole coins. 8 separate bits in your pocket could be presented and were still worth a dollar, of course.
Interestingly, "two bits" (2 bit pieces, or one quarter of the Spanish-coin-made-up-of-8-bits) remained in the vernacular of the American language. Even much later when the USA gained independence, devised and produced its own dollar, and then created a further separate coin in its currency system representing a quarter value (or 25 cents) of their American dollar — the 'quarter' coin — we still call that "2 bits" today.
Another interesting side note:
In the earlier, pre-independence days of the USA when the silver Spanish dollar coins weren't easy to acquire or find, the market forces of 'supply and demand' in the colonial society soon determined that the complete hide or processed skin of a full grown deer was worth one dollar (a single silver Spanish peso). So a dollar soon became synonymous with a "buck skin" or the shortened "buck".
It became accepted that a person could exchange a proper buck skin for goods just as well as they could a dollar (or Spanish peso) for those same goods. For many decades anyone, particularly in the more remote areas, would accept a buck skin for a dollar or give a dollar for a buck skin.
Over the years the exact reasoning became forgotten or a bit blurred and a dollar eventually became also colloquially known as a 'buck'. And that knick-name has stuck. (Even though, ironically, that today a properly prepared and tanned buck skin has grown to be worth significantly more than a single dollar - evidence of inflation buried right in the knick-name of the medium of exchange).
So, back to the topic of fiat (paper) currency...
Fiat currency: Money (paper or coin) made "legal tender" and assigned a value by government decree, with a commodity value lower than its face value, not convertible into other specie of equivalent value, and generally with a lower purchasing power than nominally equivalent specie.
The system of currency that we commonly experience and that is usual worldwide, is a fiat monetary system; it's the form of money we mostly all utilize on a daily basis. In a strict sense, all paper money systems are largely creatures of law. Any nation who is an autonomous issuer of its own currency/money, issues fiat currency.
What backs the notes a government creates? What gives these pieces of paper value? There is a bit to be said about this (as I will later on) but fundamentally it’s helpful to break down the demand for fiat money into two components. The first is acceptance value and the second is quantity value.
Acceptance value represents the public’s willingness to accept something as the nation’s unit of account and medium-of-exchange. But the government cannot simply force currency acceptance upon its users merely by stating the thing into existence and that it is now to be the nation’s medium-of-exchange. Money does not and cannot originate by order of the society (people) or State. With fiat money, the proclamation is usually downstream of the marketplace; usually after-the-fact. An order doesn't create a measure of value of the medium-of-exchange or especially doesn't create public confidence in it.
Any type of 'money' properly grows from the many and countless transactions that arise within a free market economic system between individuals. A society gradually gains confidence in a certain medium-of-exchange through many good faith transactions between individual traders/consumers, of their goods and services. It builds from what one is willing to accept as a marker or transactional medium, for something they have to offer in exchange — because they come to trust that all participants in their particular society will do the same. That is also how that particular form of money develops value relative to all the other currencies in different societies, globally. (More about this, later).
Eventually, through the legislative process and majority vote, as a society becomes a strong, stable economic state/country, the government of the people (representing a societal interest in having a stable marketplace) deem a specific thing (such as the US Dollar or Canadian Dollar) as the accepted unit of account and medium-of-exchange. But commonly, that medium of exchange is usually already in regular use by that point; it is just more or less made 'official'.
It might help to think of a tomato plant seedling.
You can't simply command it to grow in a specific patch of dirt by decree and assume it so by an edict. No, it's more like you must get out there and cultivate the soil, add nutrients, have proper access to moisture, have proper sun exposure, provide protection from elements or predators, then plant the seed in the right environment, at the right time, and mind it's growth to ensure it has maximal advantages to grow well.
It's all about creating a correct, healthy, and proper environment that encourages and promotes a vibrant, strong thing. It becomes that way through a careful, thoughtful, industrious, trusted process and never by a simple proclamation by a leader or group of representatives.
Or, like a dog you look after. You can't force him to trust you. You earn his trust through months of proven care and attention to making him feel safe, fed, and looked after. You can't simply command him to love, have confidence in, and be faithful to you.
Quantity value describes the medium-of-exchange’s value in terms of purchasing power, inflation, exchange rates, production value, etc. This is the utility of the money as a store of value. While acceptance value is generally stable and enforceable by law once society trusts and accepts everyone's participation in the system, quantity value, on the other hand, can be quite unstable and result in societal prosperity in the best cases to currency collapse in a worst case scenario.
This little 'introduction blurb' was a bit fast and general so before I go any further let me try to slow it up a little, back up a tiny bit, and explain how fiat money first appeared. Why and how it came to be.
To be continued...
Check back later and refresh the page...
I'm tired now and need to sleep.