The History of Money I — Commodity Money
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“This planet has — or rather had — a problem, which was this: most of the people living on it were unhappy for pretty much of the time. Many solutions were suggested for this problem, but most of these were largely concerned with the movement of small green pieces of paper, which was odd because on the whole it wasn’t the small green pieces of paper that were unhappy.”
― Douglas Adams, The Hitchhiker’s Guide to the Galaxy
To understand money, we must first explore where it comes from. Money is an invention; one of humanity’s greatest steps forward when it comes to civilization. With money we can facilitate trade of a lot of goods between a lot of countries. But where does the idea of money come from? What makes money valuable?
Baby Steps
Let’s pretend, for a second, that you’re a member of an ancient village. In this village also lives a farmer and a fisherman. While the fisherman can go out every day and catch fish and trade what he doesn’t eat for what he wants, the farmer can only do this once he has a crop which is about once a year. If the farmer wants to trade with the fisherman, he can’t very well ask the fisherman to save him the catch since in those days fish would spoil a mere day after it was caught. And it would be unfair to tell the fisherman that he has to give his fish to the farmer in the hopes that the farmer has a good enough harvest so he can have some in exchange for fish given to him months before. What are we to do? In this village, let’s pretend that you make shirts. You can trade your shirts to anyone in the village for anything you want, but at some point in time, the fisherman, the farmer and everyone else in the village will stop wanting your shirts and you won’t have any bargaining power. You will be unable to trade. And are you expected to wait for if the fisherman catches fish to be able to trade him a shirt for it? How do we overcome this very serious shortcoming of trading?
What we need here is a third good, something that is scarce enough, hard to copy, and that everyone wants. That ‘third good’, that universal good that has intrinsic value to it, that is money. And just like that, your village just invented a method of trading that will allow you and the fisherman and the farmer to trade all through the year, even if you might not have a ready market for your goods.
The Value of Money
When money was first invented, the underpinning idea was that that it would need to have some intrinsic value for someone to want it. That’s why commodities such as gold and silver were used as the first money. Even jewelry such as cowrie shells were used because they were durable, they were hard to counterfeit (impossible really) and they had intrinsic value because of their innate beauty. Another good example of currency being a commodity was cattle, which was used as a trading medium among tribes and nations for centuries around the world. The cattle themselves have intrinsic value because of what they can produce in terms of milk and meat, and this made them desirable because they were more than just something pretty, they brought with them more things that they could produce.
But there comes a point in our story where we have to wonder why some money even exists because it’s difficult to spot their intrinsic value. The best example of this is the island of Yap, where money is actually a massive limestone disc that weighs a couple tons and can’t be moved. People simply remember who owns which disc and they use it as a medium of exchange. And this is a very important concept, one that took the rest of the world centuries to catch up to. But we’ll cover that in a later article. For now, we’ll content ourselves with understanding what is used as money is used to represent the value of a commodity.
Inflation
Any talk about the basics of money is incomplete without the mention of that perpetual boogeyman, inflation. Inflation is a pretty simple concept to explain when it comes to commodity money. In any country there’s a finite amount of a particular commodity, let’s say gold. Now, you can only make as much coins as there is gold. once the gold runs out, you can’t simply make more gold out of thin air. So because of that, we see why gold in this sense makes for a good currency commodity — it’s durable, scarce, and if minted right, very hard to counterfeit.
Now let’s say you discover a new land across the sea and take all of the gold they have and bring it back to your home country, doubling its supply of gold. You can now mint new coins! Hooray! But you’ve run into a problem. The more coins you have circulating in the country means the less value each coin has to it. The same scarcity that gave gold its value is now less and because gold is less scarce, then it means the intrinsic value of a gold piece is less and thus you need more gold to buy something because you’re not actually spending the gold, you’re spending the value of the gold.
This is basically the reason why you can’t just print more money, because the concept remains the same. You can technically print more money, but the more you print, the less value each dollar has.
Conclusion
Understanding money as a representative of value goes a long way towards understanding more complex issues in economics. I’m no economist, simply someone who managed to fumble their way around in an effort to understand how money works and why it works. By understanding that it becomes infinitely easier to figure out how to make money, because making money is equivalent to making value. once you bring value to the market, you leave the market with money, whether that money is gold, silver or massive twenty-ton stone discs on a South Pacific island.
Originally published at https://www.linkedin.com.
