Origins of money
Money acts as the foundation for all trade and savings, so the adoption of a superior form of money has tremendous multiplicative benefits to wealth creation for all members of a society. — Vijay Boyapati.
Money is the tool that transports economic value through time and space. It enables social scalability, i.e. the improvement of social coordination.
Through history, only those goods with the best monetary properties have spontaneously emerge as money.
Listed according to their importance, the monetary properties are:
1. Verifiable Scarcity
4. Divisibility & fungibility
6. Established Monetary history
1. Verifiable Scarcity is the monetary attribute that enables the representation of value:
Humans enjoy collecting, displaying, storing and trading rare items because of genetically evolved instincts.
37000 years ago, Homo Sapiens took pleasure in collecting shells and animal teeth, making jewellery out of them, showing them off and trading them; Neanderthals did not.
Thanks to his hobby, the Homo Sapiens unconsciously created a proto-money that provided him the ability to store and transfer wealth, which meant a social coordination advantage that made him prevail against Neanderthals, despite being physically weaker.
The cost of collectibles could be finely calculated at a glance; some of them simply consisted of mnemonics that represented privileges. They were used as Store of Value transferred between generations in "life events".
2. Storability enables to protect value from theft or loss:
Those "luxuries" were durable and easy to hide.
3. Portability enables a monetary good to transfer value to different locations:
Most collectibles were also wearable, like jewellery.
The adoption of those "whimsys" implied a first step towards civilization as it enabled to mitigate aggression, since tribute was a more lucrative form of exploitation for the victor of a battle than further violence against the defeated. It also facilitated the reciprocity of favours over time, which increased food sharing.
4. Divisibility enables to split a good into different equivalent instances, while fungibility enables different instances of a good to be treated as equivalent. Both properties provide accuracy and privacy to the exchanged value:
The collectible items that, despite being scarce enough to have value density, were divisible and had a supply distribution that was accessible enough to provide them with fungibility, ended up working also as a Medium of Exchange.
During the Neolithic era (10,000 BC until 1,200 BC), money still consisted in collectibles made out more of precious metals but with a lack of uniform value. The assessment of metal was very costly, so only large merchants could do it.
Jewellery increasingly took a more divisible and fungible form until around 700 BC, when the Lydians, inhabitants of a what was a trade hub in the current Turkey, invented coinage.
The kings of Lydia, through government mints, became the first issuers of gold and silver coins.
5. Coins made it possible to entrust the verification of the authenticity of the metal to their issuers. Monetary metals thus gained capacity to be exchanged, that is, saleability; which led to the development of markets and the standardization of prices.
6. The social adoption of coins increased, so the distribution of money balances tended to
to be such that individual preferences for monetary savings over personal wealth were satisfied.
As a good is monetized and its monetary history is established, the uncertainty about its future valuation tends to reduce, which tends to stabilize its value, thus facilitating its function as a Unit of Account.
Historically speaking … gold seems to have served, firstly, as a commodity valuable for ornamental purposes; secondly, as stored wealth; thirdly, as a medium of exchange; and, lastly, as a measure of value. — William Stanley Jevons.
The adoption of a standard of value made it possible to estimate economic value, which facilitated the collection of taxes on the greater wealth that flowed through the markets.
The government monopoly on minting made it possible to abuse the debasement of coins that kept their denomination despite containing less precious metal and frequently led to price hyperinflation.
In other areas around the world many non-coinage forms of money persisted.
The origins of paper money:
In the 7th century, some Chinese merchants started to issue paper receipts that were redeemable for coins that have been entrusted to them. Nevertheless, during the 10th century the Chinese government established that the service could only be provided by authorized establishments; so the system became progressively more centralized.
During the 12th century, Song dynasty took direct control of the system and issued claims over inexistent coins; therefore, a general price inflation appeared.
By the 13th century, the paper claims ceased to be backed by any precious metal.
Image: fiat money from 14th century
The abuse of printing ended up collapsing the system. Monetary metals became again the main form of money in China again in the 15th century.
Towards the 16th century, in the West, paper receipts consisting of bills of exchange and promissory notes began to play monetary functions, enabling trade across hostile lands.
From the 17th century, the most used receipts were bank notes representing a certain amount of precious metals stored in vaults.
During the 18th century, the technological advances of the industrial revolution made easier to counterfeit coins. Not even the threat of death penalty could prevent the widespread counterfeiting of high-denomination coins. As fake coins spread, the use of the much easily verifiable bank notes grew.
Banks improved their ability to make transfers thanks to the advances in communication and transportation such as the telegraph and the train, so most monetary metals ended up in private vaults.
Vaults frequently committed fraud by issuing more certificates than the amount of metals they were storing, so most metal ended up guarded in a few large banks which end up controlled by governments that established restrictions to competition. So the issuance of paper notes, supposedly backed by precious metals, became a monopoly in each country.
The first country was Britain, which advised by Isaac Newton, introduced the "gold standard" in 1717.
By 1900 around 50 other countries adopted the same standard.
At the beginning of WWI, in 1914, the major European powers decided to suspend the convertibility of bank notes for gold, in order to fund their operations by printing at will. By the end of the war in 1918, those currencies had lost a big part of their initial value; nevertheless the British pound managed to return to its pre-WWI value in 1925.
In 1933 Franklin Roosevelt confiscated gold in the US by forbidding the hoarding of gold coin, gold bullion, and gold certificates within the continental United States (Executive Order 6102):
The US dollar was pegged to gold at 20$ per ounce but immediately thereafter, it depreciated to almost half of its previous value, with a new rate of 35$ per ounce.
During WWII (1939-1945), most of the world's gold reserves ended up in the United States, as it trade balance surplus was enormous, and it was considered the most secure location for the custody of gold reserves.
Near the WWII end, in 1944, the victors designed the Bretton Woods system as the new economic order.
The agreement established that the currencies of participating countries would be pegged to the US dollar at a fix exchange rate of 35$ per ounce of gold.
In practice, this would have required the supply of any currency including the US dollar, to not increase at a significantly higher rate than gold reserves. However, most currencies were printed at a higher rate than the US dollar, which in turn also increased at a higher rate than the stored gold.
It is not possible to keep a fixed exchange rate under those conditions, so many states were not able to defend their currency peg, and in 1971, President Nixon announced that US dollar would no longer be convertible to gold.
*Image: the nature of the US dollar changed radically during 20th century. From a gold certificate before 1933, to certificates supposedly backed by gold but not redeemable in it in 1934, to pure fiat money after 1971.
Since then, Central Banks print pure fiat money.
Economic value: benefit provided by a good or service.
Scarcity: relative low availability of something. In absolute terms, it indicates that the supply of something is not limitless.
Medium of exchange: the asset that settles a transaction. "What" a transaction is denominated in.
Means of payment: the method used to implement a transaction. "How" a transaction is manifested. E.g. credit card payments.
Currency: a generally accepted medium of exchange.