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The nature of money

Remembering what money is and how it came to be the acceptable medium of exchange

Published: 06-11-2013 00:00

The nature of money

By: Vincent Tie

“Money is not the creation of the state. It is not the result of acts of legislation and its emergence did not require a society-wide agreement of any sort. Money came into existence because the individuals who wanted to trade found a medium of exchange immediately useful. And the more people began to use the same medium of exchange, the more useful it became to them.”
-    Detlev S. Schlichter

Down through history, people have always had the need to trade and exchange goods. Barter trade is probably one of the earliest form of trading where goods are exchanged directly for other goods. If a trader A has apples while trader B has oranges, trade between them takes place if they want the goods produced by each other. They will then determine how many apples could be exchanged for an orange or vice versa.

If trader A wants oranges but trader B does not want apples, then a trade would not take place. This condition is known as the ‘double coincidence of wants’ and it substantially restricts the number of transactions that will take place in a barter economy. 

Another issue with the barter trade is that many goods are indivisible. Imagine if trader C has horses but he wants to buy an apple from trader A. Paying an apple with a horse will be an overpayment. There is no way trader C is able to divide the horse into smaller pieces to buy an apple.

Trade will be significantly more efficient if there is one good that could be used as a medium of exchange and is accepted by everyone. This good is called ‘money’. In the history of man, many different goods were used as money. Stones, shells, cattle, metal coins and paper were used as money before. Through the use of the different types of money, people gradually (and logically) defined the properties for the best form of money. 

Qualities of money

The best good to be used as money should have the following properties: scarcity, durability, portability, homogenity, divisibility and it should be a store of value. Animals are not the best good to be used as money as they are not durable in that they have limited lifespans, they are not homogenous as they can have different state of health and are not divisible into smaller units. Stones may be divisible but they are in abundance which limits their value.

Paper money comes close to meeting all the properties of good money. They are divisible and portable. Paper notes today can be made from polymer which makes them relatively durable. They can be produced in limited quantities although history tells us that every form of paper money has failed due to over issuance by man. The main quality that paper money does not have is that it is not a good store of value.

The good that is used as money should be useful in its own right. It should be a marketable commodity. The intrinsic value paper money has is essentially the value of the material – paper. This is why paper money is never just a blank sheet of paper. It is accompanied by words, fancy printed designs and laws to increase its value and give people greater confidence to accept them.

As history has shown, people have always gravitated towards accepting gold and silver as the best form of money. This is because precious metals fulfil all the properties of money very well. They were chosen not by the decree of any government nor were people forced to accept them as money. Rather people embraced precious metals as money because they gave people the most confidence to use them as a store of wealth. The ability for money to be a store of wealth is important as it allows people to postpone their purchasing power into the future.

Unlike paper money, precious metals have tremendous intrinsic value because they are scarce and require productive energy to mine them from the earth. They cannot be printed at the whim and fancy of central banks. Gold and silver hold their value very well over time. This is why they are used as money for thousands of years. Paper currencies have always been in the subservient role of a convenient claim-check to gold and silver money. Having little value in and of itself, paper currencies only point to the real money in the bank. If currencies were presented at the bank, money could be redeemed.

Paper has usurped money

Thomas Jefferson said in 1784 in a debate over money issue, “If we determine that a dollar shall be our unit, we must then say with precision what a dollar is.” In 1792, the dollar was defined as 3714/16 grains (24.1g) of fine silver. Unfortunately as of 1971, the dollar along with all paper currencies have stopped pointing to real money. What a ‘dollar’ is since then, no one knows. Subservient currencies have usurped real money. 

Without its anchor to a stable gold or silver money supply, currency supplies today have been printed to astronomical levels. Even though mainstream economists still tell us that the global financial environment is in deflation, the man on the street has seen year after year of price inflation in goods and services. The currency we hold buys less – our purchasing power continues to be eroded. 

Although we live in an age with greater understanding of technology and science, we have forgotten the history of money. We have forgotten the nature of money.