Have you ever stopped to wonder why we trust those pieces of paper in our wallets or those numbers on our bank accounts? Why do we accept them as payment for goods and services?

The answer lies in the nature of money, a concept that has fascinated human beings for millennia. From the ancient civilizations that used barley as a means of exchange to the digital currencies of today, money has taken many forms throughout history.

In this article, we will explore the definition of money, its history, and its evolution over time, as well as its future prospects.

Let’s start with the basics…

What is Money?

As economist Paul Samuelson put it:

Money is whatever people accept in exchange for goods and services.

Modern economists typically define it by the three roles it plays in an economy. In order for something to be considered money, it needs to serve as a store of value, a unit of account, and a medium of exchange at the same time.

Let’s break it down and see what each of the aforementioned roles means.

1. Store of Value

   One property of money is that it allows you to defer consumption until a later date. If perishable goods were used as money (e.g. apples), you wouldn’t be able to use them after they were rotten, thus they wouldn’t be able to serve as a store of value.

2. Unit of Account

   For something to be considered money, it needs to serve as a unit of account, meaning that it allows you to assign a value to different products and services without having to compare them directly. Instead of saying that 50 apples are worth an hour of plumbing work, you can just say that it costs $20,00.

3. Medium of Exchange

   Lastly, money needs to be widely used as a medium of exchange - as an efficient way for people to trade goods and services with one another.

For something to work as money in an economy, it needs to be able to play all 3 roles concurrently, otherwise, it will fail, as we’ll see in the following paragraphs.

History of Money

The earliest form of exchange was simple bartering, where goods and services were traded directly for other goods and services. But this system was limited by the need for a "double coincidence of wants" – the seller had to want what the buyer had to offer, and vice versa. Also, the goods and services traded often didn’t meet one or more of the properties of money mentioned in the paragraph above.

To overcome this limitation, societies began to use commodities such as seashells, beads, and stones as a more widely accepted form of exchange. Different civilizations developed different forms of currency. For example, in ancient China, cowrie shells were used as a form of currency. The Romans used silver coins called denarii, which were minted in large quantities and became widely accepted across the empire. In North America, Native American tribes used wampum belts made from shells and beads as a form of currency. These commodities met the aforementioned properties of money, but they had a serious downside; they were easy to come by.

In other words, they were soft money.

Soft Money vs Hard Money

Money has been around for thousands of years, and it has taken many forms throughout history. According to historian Niall Ferguson, the first recorded use of money dates back to the ancient civilization of Sumer, where they used barley as a means of exchange (Ferguson, 2008).

Over time, societies began to develop "hard" money, which had a higher stock-to-flow ratio* and was more durable than "soft" money.

• "Soft" money refers to money that is easily produced, transported, and destroyed, such as shells, beads, stones, and paper money.

• “Hard” money is typically more difficult to produce and is more durable, such as gold and silver.

*Stock-to-flow is a ratio that measures the total amount of a given commodity (the stock) held in reserves versus the amount that is produced (the flow) annually.

Once societies had access to "soft" money, they would develop "harder" money to replace it. That’s why economies around the world slowly switched to using metals such as gold and silver as money, which were valued for their rarity, durability, and divisibility.

For example, the Chinese began using copper coins in the seventh century BCE, and by the third century BCE, they had transitioned to using silver coins. This transition from "soft" to "hard" money was a common occurrence in many civilizations throughout history and is still relevant today (Ammous, 2018).

Paper Money

According to Niall Ferguson in his book "The Ascent of Money," paper money emerged in China during the Tang dynasty, where merchants would deposit their goods in a warehouse and receive a receipt that could be traded for goods or redeemed for the stored goods at a later time. The first paper banknotes were issued by the Ming dynasty in the 14th century.

The Gold Standard

Until the 20th century, most paper money was backed by gold or silver reserves. This meant that the government or central bank backing the money promised to redeem the notes for a certain amount of gold or silver. This system was known as the gold standard.

The gold standard worked as a system for backing currencies and providing stability to the monetary system.

Gold-backed money had several advantages, including providing stability in the value of money and limiting the ability of governments to manipulate the money supply since governments couldn’t manipulate the supply of gold backing the money.

However, the gold standard also had some significant drawbacks, such as limiting the ability of central banks to respond to economic crises and making it difficult to expand the money supply to accommodate growth. Additionally, the gold standard could be destabilized by fluctuations in the supply of gold, which were subject to the whims of the market.

According to economist Milton Friedman, the gold standard contributed to the severity of the Great Depression by limiting the ability of central banks to expand the money supply and stimulate the economy. On the other hand, proponents of the gold standard, such as economist Murray Rothbard, argue that it provided a check on inflation* and helped to prevent excessive government spending.

*Inflation refers to the sustained increase in the general price level of goods and services within an economy over a specific period of time. It means that the purchasing power of a unit of currency decreases, and it takes more money to buy the same goods or services. The most common cause of inflation is when the supply of money is expanded.

Fiat Money

In the 20th century, most countries moved away from the gold standard and adopted a system of fiat currencies. Fiat currencies are not backed by a physical commodity, but rather by the government's ability to control the money supply and manage inflation.

This can be useful during times of economic crisis, but it can also lead to inflation if too much money is printed.

To control inflation, governments can adjust interest rates to make it more or less attractive to borrow money. When interest rates are high, borrowing money becomes more expensive, and people tend to save more and spend less. This can help slow down inflation.

On the other hand, when interest rates are low, borrowing money becomes cheaper, and people tend to borrow more and spend more, which can stimulate economic growth. However, this can also lead to higher inflation.

The use of interest rates to manage the money supply is a delicate balancing act, and central banks are tasked with making decisions that balance economic growth and stability.

The Future of Money

The future of money is uncertain, but some experts believe that digital currencies could play a significant role. Bitcoin, in particular, has attracted a lot of attention due to its decentralized structure and limited supply.

As discussed earlier, one of the main problems with modern money is its lack of scarcity, which can lead to inflation and a decrease in purchasing power over time. Bitcoin, on the other hand, has a fixed supply of 21 million coins, making it "hard" money with a high stock-to-flow ratio.

Additionally, Bitcoin's decentralized structure means that it is not controlled by any central authority (read: Why Bitcoin is Unstoppable), which can help prevent issues like inflation and currency manipulation. Bitcoin also offers a high degree of security and privacy, thanks to its use of cryptography (read: Transactional Security of Credit Card vs Bitcoin).

While there are certainly challenges that need to be overcome before Bitcoin can become a mainstream form of currency, its potential advantages are hard to ignore.

Informed By:

• Friedman, M. (1963). A Monetary History of the United States, 1867-1960. Princeton University Press.

• Rothbard, M. N. (1962). What Has Government Done to Our Money? Mises Institute.

• Ammous, S. (2018). The Bitcoin Standard: The Decentralized Alternative to Central Banking. John Wiley & Sons.

• Antonopoulos, A. M. (2016). The Internet of Money. CreateSpace Independent Publishing Platform.

• https://www.investopedia.com/terms/f/fiatmoney.asp

• Blanchard, O., & Johnson, D. R. (2013). Macroeconomics. Pearson Education.

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Cover photo by Christine Roy oν Unsplash.