A Brief History of Money

Introduction

The history of money can be traced back to a time when one of the early humans received a product or service from a fellow human and reciprocated with another product or service. Money continued to change with the evolution of mankind up to its present state. It started with a simple barter, passed through various shapes including stones, pieces of metal, stamps, paper, and has now reached fiat and cryptocurrencies.

Fundamental to the changing forms of money is the concept of exchange of value. Whenever someone asks another fellow to solve one of his problems, he is actually asking to give some value. In return, the value provider also expects the same from the recipient. If the recipient returns a value to the satisfaction of the value provider, one can say that an “exchange of value” has taken place. This is also called a transaction.

The evolution of money is a journey from simplicity to complexity in sync with changing needs. As the initial human groupings settled into tribes and communities, interdependence grew which resulted in frequent exchanges. Hence, a need was felt to conduct transactions in a secure and reliable manner. With human interaction becoming more complex, money also changed its forms and continued to transform.

What is Value?

In economic terms, value is the equivalent of solving a problem. It can either be in the form of a product or a service. For example, if you are hungry and someone is providing something to eat (a product), he is adding value. If you need a haircut (a service) and someone does it for you, he is also giving you some value.

Barter Trade

Barter refers to the exchange of value. If you exchange a product with someone e.g. some quantity of wheat for a certain quantity of rice, you have conducted a barter trade. You may also exchange a product for a service or a service for a service. Barter is the oldest form of trade. It worked well when life was simple.

Limitations of Barter Trade

As civilization progressed, human needs also changed and became more complex and diverse. For example, someone wanted to exchange wheat for rice but the one who had rice wanted a goat in return. The establishment of a market, where buyers and sellers could meet and transact freely, solved this problem to some extent. Both the individuals could roam around and find someone with a goat and carry out a trilateral transaction, only if that person agreed to dispense with his goat.

Another pressing problem was that the person who offered wheat had it in less quantity than what was necessary to buy a goat. Establishing equivalence among various forms of products and services was a challenge.

Moreover, it was difficult, especially when a certain transaction was to take place among more than two parties, to agree on a particular time of the transaction, due to their conflicting needs.

Barter trade remained in practice for thousands of years. Although it is conducted even today but at a very limited scale.

Store of Value and Genesis of Money

The emergence of the concept of “store of value” pronounced the demise of barter as the normal mode of trade. In other words, this was the separation of money from value. The money which had no separate identity so far, was now to acquire one and would reside in the store of value.

What is a store of value? A certain animal, some quantity of wheat or rice, or the ability to do a haircut, all have a value of their own. You may call it intrinsic value. Now, if you say that a particular stone or a piece of metal is equal, in worth, to 100 kgs of wheat or 50 kgs of rice or one goat or 20 haircuts and everyone else agrees, you have created a store of value. Since it doesn’t have any intrinsic value but it does have a buying power, it is called a store of value. All modern-day currencies are stores of value.

The creation of a store of value solved many problems faced during the barter trade era e.g the difficulties of equivalence, timing of the trade, or in some situations the compulsion of a multi-lateral trade. It also increased the speed at which the business could be conducted.

The creation of money necessitated a central authority that could enforce the narrative that a stone or a piece of metal was worth this much (although it was actually not) and prevent malpractices associated with it e.g. scamming and counterfeiting etc. So one can say that alongside economics, politics was also evolving. These were the earliest traces of a modern state.

Primitive money came in many shapes and denominations. Some of its forms were stones, pieces of salt, animal skins, and coins of copper, silver, and gold.

This evolution was very slow and gradual and spanned over millennia. Various forms of money have been around for about 5000 years. Before that, it was the era of barter trade, predominantly.

Coin Money and Paper Currency

The first metal money (coinage) was born in China in around 1000 BC. Bronze and copper were used to make these coins. Slowly, people started using coins minted from silver and gold. Metal money was gradually adopted by other empires and civilizations as well.

Paper money was first introduced in China in approximately 700 BC. The light-weight paper currencies further facilitated the conduct of trade. The volume of international trade grew substantially with the advent of paper currencies.

Introduction of Banks

The banks were first started by Romans in around 1800 BC but disappeared with the collapse of the empire. However, by the start of the 19th century, banks had become credible institutions. When the banks came to know that depositors did not draw all their money at once, they realized that they could lend more money than they had. This was a huge step forward as the banks had acquired some control over the money supply.

Gold Standard Currency (aka Commodity Money)

In 1816, the gold standard of value was introduced in England which implied that each banknote corresponded to a certain quantity of gold held, therefore only a limited quantity of banknotes could be printed. This gave some stability and credibility to the previously unbacked currency. However, pegging the currency to gold reserves also meant that the money supply would become limited. The United States followed suit in 1900 and enacted Gold Standard Act. However, it became in-operative in the 1930s due to the Great Depression and devaluation of gold.

Unlike fiat money, commodity money is redeemable with the type and quantity of the commodity it is issued against.

Fiat Currencies – The Present Era

Before delving into fiat currencies, it is important to understand how money supply, growth, productivity, consumption, and inflation are interrelated.

In order to promote growth in an economy, there is a need to enhance productivity by starting new factories, new businesses, and expanding the old ones.

This would need additional capital. Now, if the central monetary authority (state bank, central bank, or reserve bank: different names of the same institution), in consultation with the government, decides to print money and this money is provided to various individuals and companies to enhance their productivity through installing more manufacturing capacity and improving their business practices, the overall productivity will increase and the economy will grow.

On the contrary, if the additional money that has been printed, is used for promoting consumption and not enhancing productivity, it will give rise to inflation.

This means that printing money more than the rate at which the economy is growing is double-edged. If used correctly, it can promote growth and if misused, it can lead to inflation, sometimes hyper-inflation.

However, it may be noted that consumption is also necessary to encourage productivity. If the demand dries up, the production will also slow down. Therefore, there has to be a healthy mix of consumption and productivity. It means that some degree of inflation is healthy for a growing economy. If this balance is disturbed, it can result in more inflation, slowing down growth, or both. Maintaining it is the most important function of the government and the central bank.

Fiat currency, unlike the gold standard currency (commodity money), has no underlying asset against which it is issued. Instead, it is issued by the government or central bank through an order (fiat), hence the name fiat currency. All modern currencies e.g. US dollar, Euro, British Pound, Saudi Rial, and Pak Rupee are fiat currencies.

By introducing fiat currencies, governments and central banks got better control on the money supply. Some nations used it deftly in their best interest while others could not. Although there are several other factors that affect growth and inflation, regulating the money supply can be a big plus or minus.

Modern Forms of Money

Although, by definition, modern money is fiat currency but, due to technological advancements, it has acquired new forms. Some of which are:

Online payments.
Credit and debit cards.
Digital wallets.
Various banking instruments.

Cryptocurrencies – The Future?

The current money system presumes a central authority which is the state. For example, there is no money that doesn’t belong to a country or a group of countries.

The advent of a new technology, called blockchain, made it possible to set money free from state control. This is an opportunity as well as a challenge. Cryptocurrency is only one of the many applications of blockchain technology. So far, the most popular or well-known cryptocurrency is Bitcoin which was introduced in 2009 and has since appreciated in value manyfold.

States are wary of this new form of money and are trying to grapple with it in their own different ways. Every country will have to craft a way of how to deal with this challenge or tap into this opportunity.

In all probability, cryptocurrencies are here to stay and will gradually find their rightful place in the prevailing monetary system.

Conculsion

It is fascinating to see how money has evolved alongside the economic modes of human interaction. Understanding money gives us a better handle on our financial matters. Interestingly, human evolution can also be viewed through the lens of how money has been changing its forms throughout history. Technology has also played a vital part in this journey.

How did you find this content? Please comment and give suggestions, if any.

While writing this post, I have consulted following articles:

The History of Money

The History of Money: How Our Currency Evolved from Pelts to Money

My other blog posts, you may find useful, are:

How to Make a Personal Financial Plan – Basic Considerations

Personal Finance – A Suggested Checklist

Investment vs Speculation

Why I Started a Blog on Personal Finance

Anatomy of Financial Risk

Debt, Equity, and Real Estate: An Overview

Retirement Planning