Lesson 1

The History of Money

VIDEO: Hidden Secrets Of Money Ep 1 - Currency vs Money - Mike Maloney

The Origin and Usefulness of Money as a Medium of Exchange

To understand the history of money, it is helpful to take a look at its basic function. First and foremost money is a medium of exchange. But how did it come to pass that some good was being used as a medium of exchange in the first place? As a matter of fact goods and talents are distributed unequally. Therefore people engage in barter. Let’s say Alice owns chicken and needs somebody to build a nice henhouse for her. She knows that Bob is good at building houses and asks him to help her out. For that service she offers him ten chicken. Unfortunately Bob turned vegetarian a while ago and doesn’t like eggs at all. He himself has no use for chicken. Under these circumstances a trade between Alice and Bob cannot develop. As a consequence Alice’s chicken might get caught by the fox at night and Bob will have to remain unemployed. But all of a sudden Bob remembers his friend Charlie who owns a plantation of fig trees. Charlie just told him that he’s planning to acquire some laying hens to produce his breakfast eggs by himself. What Bob will do now is building the henhouse for Alice and trade the chicken he gets in return against figs from Charlie later. So what happened? The chicken just functioned as a medium of exchange. Without Bob applying the chicken as a medium of exchange, Charlie wouldn’t have had his breakfast eggs, Bob would have stayed hungry and the fox would have killed Alice’s chicken. This primitive example shows the economic problem solved by money. When there is no double coincidence of wants between Alice and Bob, trade does not happen. Although Bob had no direct use for Alice’s chicken a coincidence of wants did take place when Bob realized that he can use the chicken as a medium of exchange for Charlie's figs. In addition to that we’ve seen that trading makes people richer: Alice doesn’t lose her chicken to the fox and Bob gets enabled to buy some food from Charlie simply by using the chicken as money. Hence it’s safe to assume that using something as money increases the wealth of a society by enabling its individuals to create more coincidences of wants and therefore more voluntary trades or win-win situations.

Marketability as Money’s Most Important Property

Now that we’ve seen the advantages of using money we can ask what specific properties qualify something for being a relatively better money than something else. For sure, the most important property of a medium of exchange is its marketability. The marketability of a good can be defined as the grade of likelihood that it will sell. The higher its marketability, the easier it is to exchange a certain good for another one. That’s exactly the property you would expect from a medium of exchange. Another way to describe the marketability of a good is the size of the network of people demanding it. The more people there are accepting one specific good in exchange for other goods, the higher its applicability as a medium of exchange is. And once people identify a good with a relatively high marketability a back coupling effect occurs: The demand for that good as a medium of exchange adds onto the primary demand for it that derives from its original usefulness. Now this additional demand increases the good’s original marketability and in turn the demand for it as a medium of exchange. Take gold as an example. Primarily it was used for religious purposes and jewelry. The demand for gold was widespread, so people started using it as a medium of exchange too and the network of gold accepting people grew bigger and stronger. Now even people with no interest at all in the primary usefulness of gold must have begun to demand gold just because of its value as a medium of exchange. And since the supply surely could not keep up with the rising demand the price of gold measured in other goods went up significantly.

Money as a Store of Value and a Unit of Account

Money is not only a medium of exchange but also a store of value and a unit of account. These can be called the secondary functions of money. They are mere consequences of an established medium of exchange. Just think about it: Whenever a certain good evolves as the universal medium of exchange it enables you to buy most of the other goods with it. Doesn’t it make sense now to compare the value of all those goods by using units of the medium of exchange as a measuring stick? Their price measured in units of money is their most effective and informative comparison to each other in terms of exchange value. If Bob wants to know how much chicken he can get for building a henhouse, he just has to look at the market price of chicken and work hours expressed in terms of money. He can charge more or less of course, but the money price of goods gives him a first orientation on how to price his service. Without the preexistence of a good used as the universal medium of exchange trying to deploy something as a unit of account would surely not be very practical.

The same is true for money as a store of value. You want your store of wealth to have a very high stability of value over time. To achieve storing your wealth over time naturally your best bet would be to use the universal medium of exchange. (We say naturally because in times of ever inflating fiat money supply this is no longer true.) Why is money a more secure store of value than any other good? Simply because you can buy all the other goods with it. Therefore the demand for all the other goods will always be a demand for money, with which people buy them – as long as the good used as money continues to be the universal medium of exchange. There is nothing you can be sure of more than that people will need money. Therefore by using money as a store of value you are relatively safe from the permanent changes in the consumption preferences of people. If you had stored your wealth in horse-drawn carriage, you would have lost through the invention of cars. But if you kept it all in money, your wealth would have been untouched by this technological innovation. Once the market has generated a universal medium of exchange it is very improbable that it will be substituted by something else soon, since every possible alternative money has the problem of a much smaller network of acceptance. Higher price volatility is the logical consequence of a smaller network of people demanding a good, because individual preferences towards this good change faster than preferences towards a good already used as the universal medium of exchange.

Further Properties of Money

Marketability surely is the first and most important property of money. But, of course, there are further properties that tip the balance of what to use as money when the original marketability of several goods is similar. Money has to be durable. You don’t want your medium of exchange to lose value, while looking for a trade partner. Charlie’s figs decay faster than Alice’s hens, so the latter are better money. But money should also be divisible without destroying it. Alice’s hen is dead when divided into pieces and cannot lay eggs anymore. Under that respect salt would be better money. The problem with salt however is transportability and density of value. Carrying a high value with salt would require big loads, whereas a gem fits in your smallest pocket. But gems are not fungible. Each one is unique and you can barely find two with the same value. An ounce of gold by contrast is just as good as any other ounce of gold unless it’s not a numismatic coin with collector’s value. And gold is not easy to counterfeit – another property you definitely want your medium of exchange to have.


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