Investing

The History of Money

Photo: Pingu1963

Money is the most common medium of exchange, representing and functioning as legal tender. But how did man develop a world in which currencies are traded speculatively, where some are pegged against others, where others float – and where money can be exchanged without money being exchanged? Surely this was a gradual process, from cavemen trading saber-toothed tiger pelts to investing in weighted baskets of currencies in real time, the development of modern money contains many interesting steps along the way. The following is what we would humorously refer to as ‘the annotated history of money’.

Money as a Commodity

Before money was paper and coin-based, it was itself a commodity, or something of intrinsic value. If a clan or tribe had an affinity for a specific bead, shell or jewel, these communities would attribute a value to these objects. This might be due to usefulness, scarcity, or aesthetic appeal. Presumably, the more rare objects carried a greater value to their admirers. In the earliest cases, commodity-based monies were traded (effectively bartered) for other things of similar value. In that sense, early monies were convertible – but only in the most basic sense. For instance, what was accepted as currency in one corner of the world, might either be extremely banal or without any worth elsewhere.

Over time, in most places, precious metals became the foremost commodity-based forms of payment. Various metals would have different prescribed levels of importance: copper would have its own value, as would silver and gold. These forms of currency both had an intrinsic value, as well as a market value. Meaning copper, for example, received for payment could be melted down and made into something else (which could presumably be traded later), or held onto and used for future payment of something else.

Early Monetary Systems

In the West, the use of precious metals as currency led to the production of coinage (coins made from the precious metals). Used as trading devices, and units of measure, coins emerged in Mediterranean societies in the 6th Century BC. The Lydians, located in modern Turkey are credited as having produced the first stamped coins in 650 BC, and experts suggest that contemporary Ionians and Greeks used similar types of coins.

The Babylonians are credited as having developed the precursor to the modern-day economic system. The Ancient text, The Code of Hammurabi (17th century BC) standardized the currency system. It also established laws regarding money, including legal fines and interest rates. In effect, this was an attempt to arbitrate commerce.

Representative Currency

The institution of coinage led to the development of representative currencies, in the form of notes. A representative currency is one which value of an exchange of goods or services is represented on a note. So, instead of paying for a new horse with a bucket of silver and gold coins, a note could be exchanged and the transaction completed. These ‘bank notes’ or ‘promissory notes’ were typically slips that proved a deposit into a bank, and could be signed over to other parties, much in the way a check is used today. The most famous form of representative currency is the British Pound Sterling. Formally developed in the late 17th century, Pounds were traded as currency, and backed by a promise to the carrier they were redeemable for gold upon the bearer’s request. A one-pound note, was therefore redeemable for one Troy ounce of gold. This was also the beginning of the gold standard incidentally, which lasted until the nineteenth century in the UK, and elsewhere through the mid-twentieth century. During this time, the notes in circulation did not exceed the gold in reserves – the strength of the currency relied on the fact that notes could be exchanged at a bank by the bearer, or that they were, as the saying goes..as good as gold.

Fiat Money

As mentioned above, representative currencies lasted until the mid-twentieth century, and since then the global economy has consisted of a number of fiat monies. A fiat currency is one declared by a government to be legal tender – and is accepted as such. Latin for “let it be”, fiat currencies are not backed by a standard – they are simply money because the powers that be say it is to be accepted as currency. Its strength lies solely in faith in the currency, and trust that the government will not induce hyper-inflation by printing money to pay off debts. Following the basic rule of supply and demand, if there is a surplus of anything, it is less dear and thus of lesser worth. So if a country decides to print more money for its own reasons, each existing note already in circulation theoretically becomes less valuable.

Because fiat money has no backing, it cannot be exchanged for gold or silver. Historically, governments have switched to fiat, either due to recession, a war-induced strain on reserves, or by ‘running the presses’ – which meant printing additional money to cover deficits and debts. In 1971, with the fiscal strain of the Vietnam War, the US declared the dollars in circulation exceeded the amount of gold in reserves, and therefore the US would no longer be backed by silver/gold standard. This would mark the end of the post-war Bretton Woods System wherein the world’s currencies were pegged at against the US dollar, which was fixed vis-a-vis silver and gold. In that sense, other currencies were of a fixed price as well (with a +/- 1% variation based on demand). Because the dollar was and remains not only the most widely-circulated currency and the currency against which other nations valued their own, all of the world’s currencies in effect became fiat-based.

Today, all currencies are fiat-based. Many economists have expressed concern over the sustainability of such a system based on trust in a hegemonic currency, the US Dollar. The rise of an increasingly global economy, with the strength of the European Union and China at the fore, combined with the recent US-led recession has caused foreign reserve banks to trade in their Dollars for other currencies. In doing so, the Dollar has lost ground to most of the world’s currencies. While many economists believe depressing a currency by increasing circulation is a way out of recession, recent events suggest that the caveats of fiat currencies are being painfully realized.