Money made the world go round, but these days it is not entirely true. As technologies become increasingly digital, the data and information becomes increasingly influential, while money lags behind. Digital payments run on decades-old rails, but the change is already in progress — in fact, it never stopped. In this series of articles, ChangeHero will cover the history of money and explain how the digital revolution transforms money.
What is Money?
Before we talk about the history of money, what do we mean by money? It is a concept familiar to everyone, but for the purpose of the article has to be defined anyway.
When economists talk about money, they mean a unit or verifiable record that is generally accepted as payment for goods and services or debts. Money has four distinct functions:
- Store of value;
Money has to retain purchasing power into the future.
- Medium of exchange;
Money has to be widely accepted in return for goods and services.
- Unit of account;
Money has to act as a common denominator in trade. It is used to interpret prices and denominate value of goods and services.
- Standard of deferred payment.
Money has to be accepted for debt settlement.
To accomplish these functions, money has to have several properties: fungibility (interchangeability), durability, divisibility, portability, acceptance, cognizability, uniformity, scarcity. Let’s break each of these down:
- Fungibility: each unit is interchangeable with any other;
- Durability: resistance to wear and tear;
- Divisibility: ability to be broken down into smaller units;
- Portability: ability to be freely carried and transferred;
- Acceptance: wide recognition and ability to be used in socio-economic context;
- Cognizability: ability to be recognized as money;
- Uniformity: units of the same denomination have the same purchasing power;
- Scarcity: limited supply in circulation.
In different stages of history of money, various objects filled these roles to a different extent. Let’s overview it from the origin of money to the steps in evolution of currency.
Barter: Money’s Predecessor?
Before the history of money, there was barter — the direct exchange of goods and services one for another. To make it possible, however, exchanging parties had to meet each other’s wants and make sure the exchange could take place. Barter is a faulty and unsophisticated system, but it allowed socio-economic relationships to emerge.
Historians and anthropologists only speculate that barter was the system which preceded money. The origin of money lies in times long before written history, and there is no evidence of a society that relied solely on barter without any medium of exchange. How did money begin, then? Let’s dive right in.
Even if barter was the original socio-economic form of interaction, relying on it was not always possible. Early forms of money emerged along with the economies. The history of money might be almost as old as human societies. What is the oldest money in the world? When was the first currency created? Since no written records survive, it is impossible to know.
An intermediate phase between pre-monetary economies and coinage was called commodity money. In it, value was represented by other objects, but the necessary condition was that the objects themselves must have value. Therefore, the change in a commodity price was alleviated because the object had value as both money and commodity.
While marginally better than barter, commodity money had its problems. It was suffering from quality deterioration, so not durable. Foods would spoil, and farmers would save the products of poorest quality to use for payments. Moreover, commodities also were not exempt from problems with transportation and associated costs, so not portable. Commodity money also lack scarcity and fungibility.
Commodity money is not a phenomenon of prehistoric times. It was observed in emerging economies such as British colonies in America in the 17th century. Some of the objects used as money there included tobacco, iron nails, pelts and even alcoholic drinks.
Coins as Money
The next step in the evolution of currency was to create a representation of value in the form of coins. The origin of money in this form is thought to be in 600 BC. The first currency we know of that had coinage belonged to the Asia Minor nation of Lydia.
Initially in the history of money, coins were minted with rare metals, such as silver or gold, which had value. The difference from the commodity money is that the value of a coin was proclaimed, regardless of the face value of a coin. This is the earliest form of fiat (from the Latin “I proclaim”) money.
As time went by, the actual composition of coins changed, for example, alloys became diluted. The price of rare metals in relation to commodities was also changing, sometimes drastically. No matter the proclaimed price, debasement was an issue even before modern history.
Some nations tried to prevent this by introducing a bimetallic standard. In such a system, gold and silver are interchangeable at a legally defined rate. Some systems used even three metals. Bimetallism has persisted well into the 19th century.
Evidently, monetary policy problems of today are not actually new. Coinage had the same problems associated with government-induced inflation.
The history of paper money started in China (not surprising — paper is also one of the great inventions of China). The earliest records of using paper notes as a medium of exchange refer to the 7th century. But the first instance of using credit notes, jiaozi, can be traced back to the 11th century. Travelers and explorers brought the concept to Europe as promissory notes in the 13th century.
In the Western history of money, banknotes were first issued as legal tender in the 17th century. As a part of the gold standard economic system, they used to be redeemable for gold and supplemental for coins. The gold standard has failed to prove price stability as early as in the colonial age which culminated around the same time.
Bank notes and paper money have started as a supplement for the gold and silver-backed monetary systems. In the early 18th century, two “bubbles” delayed the spread of paper money: the South Sea Bubble and activities of John Law in France. Mid-18th century was the time when the alternative to the coin system was quietly developing along with economic theory.
By World War I, most of the European countries have departed from the gold standard, decoupling the rare metal from national currencies. The UK returned to it a few years later, but abandoned it altogether in 1931. The US held on to the gold standard until 1977, which many economists consider to be the reason for prolonged Great Depression. By the 70s, many world economies were tied to the US dollar as a result of World War II. This move has finally made most of the world’s monetary systems into fiat currencies.
Modern fiat currencies are “backed” by “full faith and credit” in the government. It is the government’s responsibility to ensure fiat money does not lose value and can be in universal use.
Is Paper Money Ideal?
No existing form of money is ideal. Paper money meets six out of eight criteria of ideal money. It is portable, recognizable, fungible, uniform, acceptable and limited in supply at a given time. Paper is less durable against wear and tear than coins, and is not easily divisible. Fungibility and scarcity of paper money can be a point of argument depending on the point of view.
- Money is a unit or verifiable record used as a medium of exchange, store of value and unit of account. The properties of perfect money are fungibility (interchangeability), durability, divisibility, portability, acceptance, cognizability, uniformity, scarcity.
- Before any form of money existed, people chose to exchange goods and services directly in a form of barter;
- To compensate for the drawbacks of barter, people invented commodity monies. Evolution of currency started with objects that could be used as both commodities and medium of exchange;
- Earliest known coins can be traced back to 610 BC Asia Minor, and for centuries coins relied on rare metals to solidify their value;
- Paper money appeared as early as in the 11th century, but was complimentary to the coin system or represented debt rather than value. Fiat currencies as we know today appeared in the 17th century and were decoupled from gold by the 1970s. Now their value holds on the trust in the ability of the state to keep the national currency functional.
From crops to coins to notes, the history of money is as long as that of civilizations. In the 1970s, gold was no longer backing any of the world’s currencies. However, in the 1970s another groundbreaking invention was made: the Internet. In the second article, we will look at how it helps the monetary system evolve. We will also explain why digital currencies and cryptocurrencies are the next step in the evolution of currency.
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