Of all humankind’s inventions, money stands out as one of the most widespread and useful. A day probably does not go by that you don’t use it or think about it. It’s hard to imagine a time when people didn’t have money, and it can be scary to imagine what your life would be without it. From barter to shells to coin to paper to digital, the story of money spans much of human history.
Before money was invented, and in times when money was either worthless or extremely scarce, barter was used as a means for people to get what they needed or wanted. Barter is simply the act of exchanging one good or service for another good or service. An example of barter is when a farmer trades a dozen chicken eggs with a baker for a fresh loaf of bread. Although barter was more common in the past, it still exists today.
Barter is not without its downsides. Obviously, trade will not occur unless both parties want what the other party has to offer. This is referred to as the double coincidence of wants. In the example of the farmer and baker, if the baker has no need or desire for eggs, then the farmer is out of luck and does not get any bread. However, if the farmer is enterprising and utilizes his network of village friends, he might discover that the baker is in need of some new cast-iron trivets for cooling his bread, and it just so happens that the blacksmith needs a new lamb’s wool sweater. Upon further investigation, the farmer discovers that the weaver has been craving an omelet for the past week. The farmer will then trade the eggs for the sweater, the sweater for the trivets, and the trivets for his fresh-baked loaf of bread. Whew! There has got to be an easier way to do things.
The previous example illustrates the need for a more efficient means of exchanging goods and services. As a result of the downsides to barter, cultures in different times and places eventually developed money.
Regardless of the form it takes (gold bar, dollar bill, oyster shell), money is anything that functions as a medium of exchange, store of value, or standard of value. Money acts as a:
Money works best when it is has the following characteristics: portability, durability, divisibility, stability, and acceptability.
The Pacific island of Yap is known for its money, which is decidedly not portable. Large rounded stones weighing hundreds of pounds are used as a medium of exchange. If you plan on visiting Yap, wait until you are there to exchange your currency because it will not fit under the seat or in the overhead compartment of an airliner.
Across time and cultures, many things have served as money, including salt, tobacco, shells, large stones, precious and nonprecious metals, leather, and cigarettes, to name a few. Money can be a commodity in itself, a representation of a commodity, or a completely abstract symbol of value.
When relatively scarce minerals, metals, or agricultural products are used as a means of exchange, they are considered commodity money. Gold and silver struck into coins are examples of commodity money. An advantage of commodity money is that it can be used for purposes other than money. In the 1980s, many women adorned themselves in jewelry featuring gold coins, such as the Chinese Panda or the Canadian Maple Leaf. American colonists not only smoked tobacco, but they also used it as money. The salt we take for granted was at one time scarce enough that Roman soldiers were paid in it. On the other hand, a commodity’s usefulness also makes it a disadvantage to using it as money. If a country is dependent upon using a commodity for its money and as a resource, then money may be too precious to spend.
Representative money developed as an alternative to commodity money. One of the properties of gold is its high density. Transactions requiring large amounts of gold would have been unpleasant due to it being extremely heavy and difficult to transport. Goldsmiths offered a solution to this problem. By issuing receipts for gold they had on deposit, representative paper money was born. Instead of trading the physical gold, all people had to do was trade the receipts for the gold. Whenever they wanted the actual gold, they could redeem their receipts. After years of acceptance, people became more comfortable with the idea of representative paper money and the concept stuck.
Because people were already familiar with representative paper money, the next step in the evolution of money was not all that difficult to understand. Why bother making the paper money redeemable in anything? Several times in history, the convertibility of representative money into gold or silver had been halted because of war or other crises. In 1933, President Franklin Delano Roosevelt signed an executive order that transformed the dollar from being a form of representative money into what is called inconvertible fiat. Inconvertible fiat refers to both paper and virtual money that is intrinsically worthless and is not redeemable or backed by some real commodity. It is money because the government says so and we are willing to accept it. The U.S. dollar, the euro, the pound, the yen, and most other world currencies meet the definition of inconvertible fiat.
Under a gold standard, money is backed by a fixed amount of gold. You could actually trade your money for gold. The gold standard allows a country to only print as much currency as there is gold to back it up, preventing overprinting and devaluation. Downside: it acts as a limit on economic growth. As an economy’s productive capacity grows, so should its money supply. Because a gold standard requires that money be backed in gold, the scarcity of the metal constrains the ability of the economy to produce more capital and grow.