Commodity Money
Bartering has several problems, most notably the coincidence of wants problem. For example, if
a wheat farmer
needs what a fruit
farmer produces, a direct swap is impossible as seasonal fruit
would spoil before the grain harvest. A solution is to trade fruit for wheat
indirectly through a third, "intermediate", commodity:
the fruit is exchanged for the intermediate commodity when the fruit ripens. If this intermediate
commodity doesn't perish and is reliably in demand throughout
the year (e.g. copper,
gold, or wine) then
it can be exchanged for wheat after the harvest. The
function of the intermediate commodity as a store-of-value can be standardized
into a widespread commodity money, reducing the coincidence of wants
problem. By overcoming the limitations of simple barter, a commodity money
makes the market
in all other commodities more liquid.
Many cultures around the world eventually
developed the use of commodity money. Ancient China
and Africa used cowrie
shells. Trade in Japan's
feudal system was based on the koku - a unit of rice per year. The shekel was an
ancient unit of weight and currency. The first usage of the term came from Mesopotamia
circa 3000 BC and referred to a specific weight of barley, which
related other values in a metric such as silver, bronze, copper etc. A
barley/shekel was originally both a unit of currency and a
unit of weight.[6]
Where ever trade is common, barter systems
usually lead quite rapidly to several key goods being imbued with monetary
properties. In the early British colony of New
South Wales, rum
emerged quite soon after settlement as the most monetary of goods. When a
nation is without a currency it commonly adopts a foreign currency. In prisons
where conventional money is prohibited, it is quite common for cigarettes to
take on a monetary quality, and throughout history, gold has taken on this
unofficial monetary function.
Standardized coinage
A 640 BC one-third stater coin from Lydia, shown larger. From early times, metals, where available, have
usually been favored for use as proto-money over such commodities as cattle,
cowry shells, or salt, because they are at once durable, portable, and easily
divisible. The use of gold as proto-money has been traced back to the fourth
millennium B.C. when the Egyptians used gold bars of a set weight as a medium
of exchange, as the Sumerians earlier had done with silver bars. The first
stamped money (having the mark of some authority in the form of a picture or
words) was introduced about 650 B.C. in Lydia.[7]
Coinage was widely adopted across Ionia and mainland Greece during the 6th
century B.C., eventually leading to the Athenian
Empire's 5th century B.C., dominance of the region through their export of silver
coinage, mined in southern Attica at Laurium and Thorikos. A major silver vein discovery at Laurium in 483 BC led to the
huge expansion of the Athenian military fleet. Competing coinage standards at
the time were maintained by Mytilene and Phokaia using coins of Electrum; Aegina used silver.
It was the discovery of the touchstone
which led the way for metal-based commodity money and coinage. Any soft metal
can be tested for purity on a touchstone, allowing one to quickly calculate the
total content of a particular metal in a lump. Gold is a soft metal, which is
also hard to come by, dense, and storable. As a result, monetary gold spread
very quickly from Asia Minor, where it first gained wide usage, to the
entire world. Using such a system still required several steps
and mathematical calculation. The touchstone allows one to estimate the amount
of gold in an alloy,
which is then multiplied by the weight to find the amount of gold alone in a
lump.
A Persian 309-379 AD silver drachm from the Sasanian
Dynasty.
To make this process easier, the concept of
standard coinage was introduced. Coins were pre-weighed and pre-alloyed, so as long as the
manufacturer was aware of the origin of the coin, no use of the touchstone was
required. Coins were typically minted
by governments in a carefully protected process, and then stamped with an
emblem that guaranteed the weight and value of the metal. It was, however,
extremely common for governments to assert the value of such money lay in its
emblem and thus to subsequently debase the currency by lowering the content of
valuable metal.
Although gold and silver were commonly used to
mint coins, other metals could be used. For instance, Ancient Sparta minted coins
from iron to
discourage its citizens from engaging in foreign trade. In the early
seventeenth century Sweden
lacked more precious metal and so produced "plate money," which were
large slabs of copper approximately 50 cm or more in length and width,
appropriately stamped with indications of their value.
Metal based coins had the advantage of carrying
their value within the coins themselves — on the other hand, they induced
manipulations: the clipping of coins in the attempt to get and recycle the
precious metal. A greater problem was the simultaneous co-existence of gold,
silver and copper coins in Europe. English and
Spanish traders valued gold coins more than silver coins, as many of their
neighbors did, with the effect that the English gold-based guinea coin began to
rise against the English silver based crown in the 1670s and 1680s.
Consequently, silver was ultimately pulled out of England for dubious amounts of gold
coming into the country at a rate no other European nation would share. The
effect was worsened with Asian traders not sharing the European appreciation of
gold altogether — gold left Asia and silver left Europe
in quantities European observers like Isaac
Newton, Master of the Royal Mint observed with unease.
Stability came into the system with national
Banks guaranteeing to change money into gold at a promised rate; it did,
however, not come easily. The Bank of England risked a national financial
catastrophe in the 1730s when customers demanded their money be changed into
gold in a moment of crisis. Eventually London's
merchants saved the bank and the nation with financial guarantees.
Another step in the evolution of money was the
change from a coin being a unit of weight to being a unit of value. a
distinction could be made between its commodity value and its specie
value. The difference is these values is seigniorage. See also: Roman
currency, coinage metal, for conversions of the European coins
before the introduction of paper money: The Marteau Early
18th-Century Currency Converter.
Representative money
An example of representative money, this 1896 note could be
exchanged for five US Dollars worth of silver.
Representative money refers to money that consists
of a token or certificate made of paper (legal
tender). The use of the various types of money including representative
money, tracks the course of money from the past to the present.[10]
Token
money may be called “representative money” in the sense that, say, a piece
of paper might 'represent' or be a claim on a commodity also.[11]
Gold certificates or Silver certificates are a type of
representative money[11]
which were used in the United
States as currency until 1933.
The term 'representative money' has been used in
the past "to signify that a certain amount of bullion was stored in a
Treasury while the equivalent paper in circulation" represented the
bullion.[12]
Representative money differs from commodity
money which is actually made of some physical commodity. In his Treatise
on Money,(1930:7) Keynes distinguished between commodity
money and representative money, dividing the latter into “fiat money”
and “managed money.”
Fiat money
Fiat money refers to money that is not backed by
reserves of another commodity. The money itself is given value by government fiat
(Latin for
"let it be done") or decree, enforcing legal tender laws,
previously known as "forced tender", whereby debtors are legally
relieved of the debt if they (offer to) pay it off in the government's money.
By law the refusal of "legal tender" money in favor of some other form
of payment is illegal, and has at times in history (Rome
under Diocletian,
and post-revolutionary France during the collapse of
the assignats)
invoked the death penalty.
Governments through history have often switched
to forms of fiat money in times of need such as war, sometimes by suspending
the service they provided of exchanging their money for gold, and other times
by simply printing the money that they needed. When governments produce money
more rapidly than economic growth, the money supply overtakes
economic value. Therefore, the excess money eventually dilutes the market value
of all money issued. This is called inflation.
See open market operations.
In 1971 the US
finally switched to fiat money indefinitely. At this point in time many of the
economically developed countries' currencies were fixed to the US dollar (see Bretton Woods Conference), and so this
single step meant that much of the western world's currencies became fiat money
based.
Following the first Gulf War the
president of Iraq,
Saddam
Hussein, repealed the existing Iraqi fiat currency and replaced it with a
new currency. Despite having no backing by a commodity and with no central
authority mandating its use or defending its value, the old currency continued
to circulate within the politically isolated Kurdish regions of Iraq. It became
known as the "Swiss dinar". This currency remained
relatively strong and stable for over a decade. It was formally replaced
following the second Gulf War.
Credit money
Credit
money often exists in conjunction with other money such as fiat money or
commodity money, and from the user's point of view is indistinguishable from
it. Most of the western world's money is credit money derived from national
fiat money currencies.
In a modern economy, a bank will lend to
borrowers in excess of the reserve it carries at any time, this is known as fractional reserve banking. In doing so,
it increases the total money supply above that of the total amount of the
fiat money in existence (also known as M0). While a bank will not have access
to sufficient cash (fiat money) to meet all the obligations it has to
depositors if they wish to withdraw the balance of their cheque accounts
(credit money), the majority of transactions will occur using the credit money
(cheques and electronic transfers).
Strictly speaking a debt is not money, primarily
because debt can not act as a unit of account. All debts are denominated in
units of something external to the debt. However, credit money certainly acts
as a substitute for money when it is used in other functions of money (medium
of exchange and store of value).
