“The quickest way to double your money is to fold it in half and put it in your back pocket.”
In this article, we will explore all the forms money has taken during our civilized history. In order to understand why some of these forms of money have succeeded or failed over a period of this, we need to first understand the functions that money serves. Economists agree that money “should” serve these three functions; Money should be a store of value, unit of account and a medium of exchange.
We will explore these functions of money in detail through examples of different forms of money today.
The Barter System
The barter system is a method that was used to exchange goods or services directly for goods or services without using a medium of exchange (such as today’s fiat currency). This method was useful when both parties have something they want from each other. They would agree on the amount of item/service and simply swap it.
However, as transactions increased and trades expanded across borders, the inconveniences and issues also escalated:
1. Lack of Double Coincidence of Wants
Double Coincidence of Wants means what one person wants to sell and buy must coincide with what some other person wants to buy and sell. It’s difficult to have a constant supply of other traders who want to trade with another for the same goods.
2. Lack of common measure of value
There is no fair or accurate measurement of the value of one traded item relative to the other. Some cultures, particularly in the west, may perceive the value to trade 1 cow as 10 chickens, while in a nation like India would require 100 chickens to trade 1 cow because they value cows more.
3. Storing and Transporting Issues
It is difficult for people to store and transport wealth or goods like cattle, wheat, potatoes, etc. This is because some goods expire over a period and some require larger transport vehicles due to their weight. Plus, there is a high risk of robbery if someone is carrying a truck full of gems from one town to the other.
4. Indivisibility of Goods
If a trader wants to sell his goat and get in exchange silk equal to the value of half of his goat, he cannot do so without killing his goat.
If there is one thing that we learnt from the barter system is that money should also hold the following characteristics; Money should be durable and portable, while cattle are fairly durable, long trips can cause cattle to get sick, portability of say cow, however, is much more difficult than a $20 note which can be kept inside your pocket and is way more durable than a cow.
Money should be divisible, as you can see from point 4 above, cattle is clearly not. Money should have a certain amount of uniformity, cattle may come in different shapes and sizes and that would represent that they all have a different value, all $20 bills would be the same shape and sizes.
Money should be limited in supply, simple supply and demand economics will tell you that an excess in supply of money may cause its value to decrease, limited supply of money is essential to maintain it as a store of value, if cattle were indeed used as money, ranchers will try to increase supply of cows, a banknote similarly will lose value if the central bank of a country decides to print more money.
This has been witnessed throughout history, like post-WW1 Germany or in most recent memory likes of Zimbabwe and Venezuela. And lastly, money should be acceptable, this goes back to this first point above, using goods and services as a medium of exchange may lead to lack of double coincidence of wants. Cattle are not acceptable for everyone, just like a British pound will not be accepted in New York City.
Introduction to Money
Money was invented by society to overcome the above drawbacks of the barter system.
1. Commodity Money
Commodity money is created from a good as a medium of exchange. In 1000 B.C., China started to use metal as money to represent the value of an item. The coins were made from bronze and copper. The popularity of coins then spread to Lydia in Turkey between 600 to 500 B.C where King Alyattes of the Lydian Empire introduced coins called the Lydian Stater that were made from a naturally-occurring metal alloy of 55% gold and 45% silver.
The design of the coin represented the city with foreparts of the lion on the left and a bull on the right, whereby the lion represented the official tender of the king in his kingdom. Comparison to China, Turkey-based the value of their coins on the supply of gemstones. Also, the Lydian Stater is considered to be the first coin officially issued by the government in world history.
2. Paper Money
Although the adoption of commodity money began to grow, China was already transitioning towards paper money as a result of the precious metal shortage, transport and storage issues.
One of the first forms of paper money existed in the Tang dynasty but the Song Dynasty was the first to introduced banknotes called Jiaozi in the Szechuan capital of Chengdu that was issued by banks in around 960 (10th century AD). Jiaozi was backed by commodities such as gold, silver and gems.
Thus, the bank noteholders were able to use them to convert to commodity money at any of the issuing banks. However, due to poor management of the paper money supply and inflation, the Jiaozi bank notes eventually fell out. Yuan Dynasty came about with their paper money called Jiaochao which was known as the first currency that was a predominant circulating medium.
As years passed by, the conception and utility of paper money continued to grow across the globe:
- In the 1600s, the Bank of Stockholm in Sweden began to issue their own banknotes that was accepted by the parliament and backed by silver.
- In the 17th century, France initially used paper money backed by gold and silver to pay the military when there was a lack of coins supply. Eventually, the popularity caught on and by 1757, the government acknowledge its utility, discontinued all payments in coins and enforced all payments to be made with paper money instead.
- In the early 1800s, the UK issued their banknotes that were backed by gold.
- In the 1860s, the U.S government also issued their own paper money called, “United States Notes” (or “greenbacks”) during the American Civil War.
3. The Bretton Woods Agreement
After numerous years of conflicts across nations during the World War I and World War II and the 1929 Great Depression, representatives of 45 countries came together for a conference in Bretton Woods, New Hampshire in 1944. The purpose of the meet was to stabilize the different national currencies and help rebuild their respective economies post-war and avoid hyper-inflation and trade wars.
The Bretton Woods agreement entailed that participating countries must maintain fixed exchange rates between their currencies and the U.S dollar, while the U.S dollar was backed by gold reserves. At the time, the U.S held ¾ of the world’s supply of gold and no other nations had enough gold to back its replacement.
With the shift from the gold standard, the U.S Dollar became the new international measure for currency valuation. The U.S dollar was fixed at $35 per ounce of gold and the central bank could only exchange gold for U.S dollars, no other currencies.
The Collapse of the Bretton Woods System and the Rise of Fiat Currency
Unfortunately, the stability did not last long as gold was running out (the issue of having the US dollar as the global currency for gold exchange) and by 1971, President Nixon decided to the Bretton Woods Agreement. This event and many other economic decisions made by President Nixon shocked the world and is historically known as “The Nixon Shock.” By 1973, the Bretton Woods system was completely replaced by the current regime whereby paper money is no longer backed by U.S dollar or gold; instead, it’s based on free-floating fiat currencies.
Fiat currency is a legal tender backed by a central government or central bank, usually in the form of notes and coins or even bank credits. The trust of the national currencies has been moved from the commodities and to the respective national governments.
Since the establishment of the fiat currency regime, issues of its management and utility have increased which eventually led to the founding concept of cryptocurrency in the 1990s. Although fiat currency is still currently widely used, many successful cryptocurrency projects have brought to question whether it would remain its popularity in the future.
If we were to assess the modern fiat currencies on the same scale as barter trade, we would see that there are some issues surrounding fiat currencies, while fiat currencies may serve all the functions of money, in that, they are a store of value, a unit of account and a medium of exchange.
It can be argued how far this holds in today’s world, USD has lost nearly 80% of its purchasing power against gold since the collapse of Bretton woods, hence things are way more “expensive” now. Furthermore, we now live in a society which is way more globalised and inter-connected through the world wide web.
The US Dollar or any other currency is not a good medium of exchange when you move to a different country e.g you can’t go around paying your rent in Singapore in Australian dollars, in today’s world we also see modern fiat currencies are not a great medium of exchange on the Internet. Cross- Borders payments remain a massive problem online and offline.
It would still take me at least a couple of days to move money from one country to another country and it is still the reason why some online services stay unavailable in your jurisdiction because in many cases they just do not know how to receive your payment.
Money will continue to evolve over time, we could argue that money is already evolving with the introduction of e-wallets, digital banks, peer to peer lending and most importantly, for the purpose of this article, cryptocurrencies, like Bitcoin.
We see today that fiat currencies are also beginning to falter on some of the basic characteristics of money that the humans have so elegantly learnt from our past endeavours. While fiat is still portable, uniform and durable, so is a Bitcoin (and so are its Satoshi’s).
In terms of divisibility one could argue that cryptocurrencies are way more divisible than fiat currencies, ever found yourself looking for change? Guess what, don’t need to with Bitcoin.
Fiat currencies are also not limited in supply, now a traditional economist will tell you that the supply of money is controlled by the central bank, we often see what the Federal Reserve calls “Quantitative Easing” which is introduction of new money into supply, so the supply of Fiat currencies is not “fixed”.
Furthermore, historically we have seen that when you put the money supply in the hands of the autocratic leadership, there is often misappropriation in terms of the money supply. While Bitcoin’s supply is fixed, perhaps the biggest criticism that a digital currency like Bitcoin faces is on its acceptability, you can’t pay for a beer at your local with Bitcoin (unless you have a super progressive local), but then again the technology is still at its inception.
One could argue that it is still the best method of making cross-border payments available today. The US Dollar was introduced in the 1700s, however even until 1933, people carried gold coins in their pockets, and paper bills were exchangeable for gold and silver coins at any bank. Perhaps the greatest use of this digital cash will only be online.
The great economist Milton Friedman was the first to foretell the coming of Bitcoin,
“The one thing that’s missing, but that will soon be developed, is a reliable e-cash, a method whereby on the Internet you can transfer funds from A to B, without A knowing B or B knowing A.”