Money

The History of Money and Banking – Kasra Kaveh – Medium

Sometimes we know things, but most of the times we mistakenly think that we do. One of the rare situations that we can fully understand the distinction between these two, is when we find ourselves in the state of defining that phenomenon we thought we have digested before. What is money? Why in exchange for some colored paper or coins can we buy goods? How does that money have equal value for that good? Is the secret value of money hidden in its paper material or in the alloy of the coin? Is it somehow hidden in the shapes and markings and numbers written on them? In this article, we plan to study the quiddity behind money and its evolution through time.

Money is any item or verifiable record that is generally accepted as payment for goods, services, and repayment of debts, such as taxes in a particular country or socio-economic context. The main functions of money are distinguished as a medium of exchange, a unit of account, a store of value and sometimes, a standard of deferred payment. Any item or verifiable record that fulfills these functions can be considered as money. However, these functions were not expected from money since the very start. Needless to say, the concept of money didn’t always exist.

Barter

The oldest method of exchanging goods and services, with more than one hundred thousand years of history, is barter. Barter is a system of exchange in which participants in a transaction directly exchange goods or services for other goods or services without using a medium of exchange. Sometimes anthropologists identify barter as a “silent trade” or “dumb trade” which relates to the possibility of absence of any common language between two parties of trade. A farmer could interchange his wheat with a herder’s goat. It is assumed that in this system, all the functions mentioned earlier about money should be accumulated in the nature of the good itself, which in this case, it is not. It is clear that the good itself can play the role of medium of exchange, and before it decays, it can maintain its value, but nothing more.

Let’s consider the advantages and disadvantages of this mode of trade. Since direct barter does not require payment in money, it can be utilized when money is in short supply, when there is little information about the creditworthiness of trade partners, or when there is a lack of trust between both parties. It is also good for those who cannot afford to store their small supply of wealth in money, especially in hyperinflation situations where money devalues quickly.

The limitations of barter are often explained in terms of its inefficiencies in facilitating exchange in comparison to money. For barter to occur between two parties, both parties need to have what the other side desires-double coincidence of wants-. In a monetary economy, money measures the value of all goods, so that their values can be assessed against each other; this role may be absent in a barter economy -no common measure of value-. If a person wants to buy a certain amount of merchandise but has only one indivisible unit of another good which is worth more than what the seller requires, a barter transaction cannot occur -indivisibility of certain goods-. If a society relies exclusively on perishable goods, storing wealth for the future may be impractical. However, some barter economies rely on durable goods like sheep or cattle for this purpose -difficulty in storing wealth-.

Commodity Money

Around 2500 BC in Sumer, a few commodities were used as a medium of exchange. These very small number of items were accepted by society and were used to pay for different items. The earliest commodities that were used as money were barley, wool, and silver in other places and times where people didn’t have access to any of these commodities, they sometimes used other things like oxen in ancient Greece, elephants in Sri Lanka or human skull in Brunei and sometimes even stones. There is an archipelago on the Pacific Ocean named Yap where people used relatively large limestone rocks — in the shape of a disk with a hole in the middle of it — as money. They put a stick through the hole in order to pose it on its edge. Surprisingly, after the bargain was set they didn’t feel the need to move the stone and they just exchanged the ownership of that stone. On the other hand, the value of the limestones was not solely defined by their size but the cost of bringing the limestone to the island determined the value of it.

Another odd example is a small population in Papua of New Guinea — the last population on the Earth which came in contact with the rest of the human race around 1930 — where people used shells as commodity money. When Australians in search of gold reached the island and found out about their commodity money, they flew back to Australia and brought thousands and thousands of shells to Papua. The excess shells brought into the local economy by Australians created price inflation in Papua and as a result, shell money was abolished in 1933.

In this mode of trade, society accepts some specific commodity as a medium of exchange and based on the characteristic of that commodity, defines the functions it can possess in the role of money. But like barter, it had some attributes within itself but lacked in some functions like playing the role of an accounting unit. As the number of goods rises, the calculation for finding the correct amount of one good in comparison to another one raised in complexity exponentially.

We can see some fundamental differences between silver, wool, and barley and the shell or stone as commodity money. The first group had some intrinsic value but the second group did not. This shift in the concept layer of money didn’t end there and later we can track the growth of this idea in the representative and fiat money discussion.

Coinage

Next stop in the evolution of payment is coinage in which the commodity is put into a certain form we call coin. The first coins of any substantial value and qualification were formed and used in Lydia — Western Turkey bordering on the Mediterranean Sea — around 640 BC, weighing about the same as a US nickel. Three coins were a soldier’s monthly pay. These first coins were made of electrum, a combination of gold and silver found in riverbeds below volcanic mountains.

Just in 25 years or so, the idea of using coins as a medium of exchange spread and Greece, the neighboring country, started using and making their own coins. In 330 BC, coins with the image of Alexander the Great were minted in vast quantities. This spread the idea of coinage far and wide. Since then, coinage has always been present as a medium of exchange. This is the first time in history that all the functions expected from money, could be used. However, we must consider the vital need of supplying gold and silver in order to meet the demand in place.

So far we’ve studied the main steps in the evolution of money since before there were even languages around till the birth of the idea of paper money in China, which we are going to study in detail in another article.


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