The news is by your side.

- Advertisement -

Forms of Money

0 1

Get real time updates directly on you device, subscribe now.

The concepts and eras I want to touch on are:
• Barter (let’s exchange valuable things)
• Commodity money (the money is the valuable thing)
• Representative money (the money is a claim on the valuable thing)
• Fiat currency (the money is completely de-linked from any valuable
thing)
Barter
It is common knowledge that before money existed transactions were
carried by exchanging goods when both parties agreed on the deal. ‘Sir,
your five ugly old sheep for my twenty bushels of fine corn’. But barter is
difficult. It is very rare that you want something the other person has, and
at the same time, they want something you have, and that you’re both
prepared and able to make a trade. Economists call such a rare situation a
‘double coincidence of wants,’ and aside from market days in subsistence
economies this situation almost never occurs. So, the argument goes,
money was invented to lubricate the deal. Money is something that
everyone is happy to accept in exchange for other things, so it serves as
the intermediary asset for the times when you don’t have something that
the other person wants. In summary, the inefficiency of barter gave rise
to money.
This elegant argument seems intellectually neat. Unfortunately, however,
there is not a shred of evidence for it. It is pure fantasy—the textbooks are
wrong! When you hear someone talk about money being invented to
replace barter, do please educate them or talk to someone else.
Money solving the inefficiencies of barter is a myth popularised in 1776
by Adam Smith in The Wealth of Nations. Ilana E Strauss discusses this
in an amusing and eye-opening read, ‘The Myth of the Barter Economy’
published in The Atlantic19, in which she quotes Cambridge Anthropology
Professor Caroline Humphrey in a 1985 paper, ‘Barter and Economic
Disintegration’20:
‘No example of a barter economy, pure and simple, has ever been described, let alone the
emergence from it of money, … All available ethnography suggests that there never has been
such a thing’.
Economies developed based on mutual trust, gifts and debt or social
obligations—‘Have a chicken now, but please remember this for later’.
Early communities were small and stable, and individuals tended to grow
up with each other and know each other well. Reputation within a
community was crucially important, so people didn’t tend to renege on
their word. But people still had to keep some sort of record of debts or
favours owed. Trading (the simultaneous exchange of non-monetary
goods) did exist, but mainly occurred where there was a lack of trust, for
example with strangers or enemies, or where there was a strong
possibility that debt wouldn’t be remembered or couldn’t easily be repaid,
such as with travelling merchants.
The emergence of money to solve the problem of repaying a debt or
favour makes more sense than the emergence of money as a solution to
the double coincidence of wants. Indeed, David Graeber details the
existence of debt and credit systems before money, which itself appeared
before barter, in his fascinating and influential book Debt: The First
5,000 Years21.
Commodity Money
With commodity money the physical token that is transacted is itself
valuable, for example grain, which has intrinsic value, or precious metals,
which have extrinsic value.
Good forms of commodity money have a stable and known value and are
relatively easy to keep and exchange, or ‘spend’. They also need to be
consistent, and a standardised unit makes things easier. Examples are
standardised quantities of grain or cattle, which have intrinsic value by
being edible, and precious metals or shells, which have extrinsic value by
being both scarce and beautiful.
Note: An argument that cryptocurrency proponents like to use is that the
tokens should be valuable because they are scarce (‘There will only be 21
million bitcoins ever, so that is what makes them valuable!’). This is not a
solid argument. Something may be scarce, but that doesn’t mean it is, or
should be, valuable. There must be one or more underlying factors that
make it desirable—beauty, utility, something else. And these underlying
factors must create demand for the item. The two underlying factors in
Bitcoin that create demand are:
1. It is the most recognised instrument of value that can be transmitted
across the internet without needing permission from specific
intermediaries.
2. It is censorship resistant.
Representative Money
Representative money is a form of money whose value is derived by being
a claim on some underlying item, for example a receipt from a goldsmith
for some gold they are safekeeping. The receipt may be passed to another
party to transfer that value. You could say that the value of the token is
backed by the value of the underlying asset. Warehouse accounts or
receipts (or ‘tokens’) are backed by the value of the goods contained in
the warehouse and are good examples of representative money.
Representative money differs from commodity money in that it relies on
a third party (e.g., the manager of the warehouse or the goldsmith) to be
able to supply the underlying item on redemption of the tokens, so there
is some counterparty risk: What if the third party fails?
Representative money tokens were similar to bearer bonds, where the
person holding a piece of paper was entitled to reclaim the value of the
underlying asset (sometimes on demand, sometimes on a due date).
These tokens were used as we use cash today to settle transactions, and
were a stepping stone between use of commodity money (e.g., precious
metal coins) and fiat currency.
Fiat Currency
Commodity money was gradually replaced by representative money
which in turn has now almost entirely been replaced by ‘fiat money’. All
major recognisable sovereign currencies now are fiat. Fiat (pronounced
fee-at, Latin for ‘let it be done’) is money because legislation says so,
rather than because it has a fundamental or intrinsic value. Fiat money
neither has intrinsic value nor is it convertible22. Statements on banknotes
often say something along the lines of ‘I promise to pay the bearer on
demand the sum of …’ but you won’t get very far if you go to the issuer of
the fiat currency—usually the central bank—and say, ‘Hey, give me some
of the underlying asset back for this’. At best you will get a new banknote.
So how and why are fiat currencies valuable? Two main reasons:
1. They are declared by law as legal tender, meaning that in that legal
jurisdiction it must be accepted as valid payment for a debt.
Therefore people use it.
2. Governments accept only their own fiat for tax payments. This gives
fiat currencies a fundamental usefulness, as everyone needs to pay
tax23.
The Economist newspaper has described cryptocurrencies as having fiat
characteristics24 as it is simply declared so, but to date, cryptocurrencies
have not been declared legal tender in any nation. We will discuss legal
tender later in the book.

 

Get real time updates directly on you device, subscribe now.

Leave A Reply

Your email address will not be published.

Subscribe to our newsletter
Sign up here to get the latest news delivered directly to your inbox.
You can unsubscribe at any time

This website uses cookies to improve your experience. We'll assume you're ok with this, but you can opt-out if you wish. Accept Read More