Money & Currency: History & Development

Since the beginning of time people have bartered, which is an exchange of goods and services for other goods and services. However, for those who couldn’t agree what something was worth in exchange or if one party does not want what the other party has, a new system had to be created. This system is called commodity money.

From the earliest commodity, which is a basic item used by everybody (salt, tea, tobacco, cattle, seeds, etc.)(2), problems would occur. Problems such as carrying bags of salt and other commodities are extremely hard, and commodities are also difficult to store or are even perishable. Metal objects are introduced as money around 5000 B.C but during 700 B.C the Lydian’s became the first in the western world to really make coins(2). Different countries soon started minting their own series of coins with specific values. In this time period, metal is used because it is readily available, easy to work with, and could be recycled. Because coins represent a certain value, it is easier to compare the cost of items people want.

With the introduction of paper currency and non-precious coinage- commodity money evolved into representative money. Representative money means that money itself does not have to be made of expensive materials any longer. Representative money or the idea of paper money was backed by governments or banks promise to exchange it for a certain amount of silver or gold. For the majority of the nineteenth and twentieth century representative money was based on the gold standard, which is a monetary system in which the standard economic unit of account is a fixed weight of gold. For example, the old British pound bill had once been redeemable for a pound of sterling silver.

Representative money has now been replaced by fiat money. Money is now given a value by a government fiat or a decree, basically enforceable legal tender laws are now in effect. Technically by law, the refusal of “legal tender” money in favour of some other form of payment is illegal. When the fiat money is used as a currency, it is referred to as fiat currency (3). Today, most of the national currencies are fiat currencies, including the Euro and US dollar. This huge change was caused because of the Nixon Shock, the period of time in 1971 where President Nixon issued a series of economic measures to cancel the direct convertibility of the United States dollar to gold.

Gresham’s law is stated as, “Where legal tender laws exist, bad money drives out good money”(4). This law is applied when there are two forms of money in circulation which are forced, by the application of legal law, to be respected as having the same face value in the marketplace. Good money is referred to as money whose face value is equal to the intrinsic or historic value of the material it is made of. For example, prior to the 1900’s, the US dollar would be worth 1/20.67 ounce of gold. Bad money is equivalent of money that has an intrinsic or historic value less than its face value, for example, coins that are “debased”, usually by cutting or scraping some of the metal off. Another example of bad money is counterfeit coins. In modern times bad money is recognised as, for example, the 1965 US half-dollars which are made from only 40% silver. The previous year, the half dollars worth amounted to 90% silver. With the release of the 1965 dollar, which was legally required to be accepted at the same value as the previous year’s 90% halves, the older 90% silver coinage began to be hoarded while the debased money continued to circulate instead(4). This is the similar to the theory of survival of the fittest in humanity, the more useful coin will reign for the longest time, and if that means the cheaper coin, then so be it. The thinking behind Gresham’s law is that people will spend the “bad” coins rather than the “good” ones and continue to save the “good” ones for their appreciate value, despite their face value.

Fractionally backed money is basically money that doesn’t exist, money that is created by banks on the idea that people that loan the bank money will never want it all back at once(1). To further explain this idea, I will give a real life example. Suppose a teenager, Daniel, decides to deposit one thousand dollars of hard earned cash into his checking account at the bank. Under a hundred percent reserve banking system, this would be the end of the story, but unfortunately there is no such thing. In the act of depositing this money, Daniel’s currency holdings would fall by one thousand dollars, while his check book balance would rise by one thousand dollars. Putting the money in the bank wouldn’t affect the total amount of money in the economy at all. In this society Daniel’s bank would see a new profit opportunity from this deposit. After the bank put the one thousand dollars of currency into its vault, its reserves would rise while its outstanding deposit liabilities will have risen by one thousand dollars. But since the banks are subject only to a reserve requirement, which is approximately only 10 percent, the bank would have new excess reserves of nine hundred dollars. If the bank finds a suitable borrower, the bank would have the legal ability to grant Daniel’s money as a loan for this amount. Thus, the bank creates 900 dollars that does not exist and lends it out to others with the knowledge that it is in everyone’s intention to pay the bank back.

In current day , money has completely transformed almost going completely paperless. Every store or business now owns an electronic merchant which basically allows a person to pay for virtually anything with funds that exist or are loaned to said person, anywhere. Technology is reaching such great lengths that you can literally pay for a sofa or a television with your cell phone, with an application called smartswipe which basically links a phone to a bank account and therefore allows for purchases to be made. The idea of paperless money is soon to be made a reality.

Since the beginning of time people have bartered, which is an exchange of goods and services for other goods and services. However, for those who couldn’t agree what something was worth in exchange or if one party does not want what the other party has, a new system had to be created. This system is called commodity money. From the earliest commodity, which is a basic item used by everybody (salt, tea, tobacco, cattle, seeds, etc.)(2), problems would occur. Problems such as carrying bags of salt and other commodities are extremely hard, and commodities are also difficult to store or are even perishable. Metal objects are introduced as money around 5000 B.C but during 700 B.C the Lydian’s became the first in the western world to really make coins(2). Different countries soon started minting their own series of coins with specific values. In this time period, metal is used because it is readily available, easy to work with, and could be recycled. Because coins represent a certain value, it is easier to compare the cost of items people want.

With the introduction of paper currency and non-precious coinage- commodity money evolved into representative money. Representative money means that money itself does not have to be made of expensive materials any longer. Representative money or the idea of paper money was backed by governments or banks promise to exchange it for a certain amount of silver or gold. For the majority of the nineteenth and twentieth century representative money was based on the gold standard, which is a monetary system in which the standard economic unit of account is a fixed weight of gold. For example, the old British pound bill had once been redeemable for a pound of sterling silver.

Representative money has now been replaced by fiat money. Money is now given a value by a government fiat or a decree, basically enforceable legal tender laws are now in effect. Technically by law, the refusal of “legal tender” money in favour of some other form of payment is illegal. When the fiat money is used as a currency, it is referred to as fiat currency (3). Today, most of the national currencies are fiat currencies, including the Euro and US dollar. This huge change was caused because of the Nixon Shock, the period of time in 1971 where President Nixon issued a series of economic measures to cancel the direct convertibility of the United States dollar to gold.

Gresham’s law is stated as, “Where legal tender laws exist, bad money drives out good money”(4). This law is applied when there are two forms of money in circulation which are forced, by the application of legal law, to be respected as having the same face value in the marketplace. Good money is referred to as money whose face value is equal to the intrinsic or historic value of the material it is made of. For example, prior to the 1900’s, the US dollar would be worth 1/20.67 ounce of gold. Bad money is equivalent of money that has an intrinsic or historic value less than its face value, for example, coins that are “debased”, usually by cutting or scraping some of the metal off. Another example of bad money is counterfeit coins. In modern times bad money is recognised as, for example, the 1965 US half-dollars which are made from only 40% silver. The previous year, the half dollars worth amounted to 90% silver. With the release of the 1965 dollar, which was legally required to be accepted at the same value as the previous year’s 90% halves, the older 90% silver coinage began to be hoarded while the debased money continued to circulate instead(4). This is the similar to the theory of survival of the fittest in humanity, the more useful coin will reign for the longest time, and if that means the cheaper coin, then so be it. The thinking behind Gresham’s law is that people will spend the “bad” coins rather than the “good” ones and continue to save the “good” ones for their appreciate value, despite their face value.

Fractionally backed money is basically money that doesn’t exist, money that is created by banks on the idea that people that loan the bank money will never want it all back at once(1). To further explain this idea, I will give a real life example. Suppose a teenager, Daniel, decides to deposit one thousand dollars of hard earned cash into his checking account at the bank. Under a hundred percent reserve banking system, this would be the end of the story, but unfortunately there is no such thing. In the act of depositing this money, Daniel’s currency holdings would fall by one thousand dollars, while his check book balance would rise by one thousand dollars. Putting the money in the bank wouldn’t affect the total amount of money in the economy at all. In this society Daniel’s bank would see a new profit opportunity from this deposit. After the bank put the one thousand dollars of currency into its vault, its reserves would rise while its outstanding deposit liabilities will have risen by one thousand dollars. But since the banks are subject only to a reserve requirement, which is approximately only 10 percent, the bank would have new excess reserves of nine hundred dollars. If the bank finds a suitable borrower, the bank would have the legal ability to grant Daniel’s money as a loan for this amount. Thus, the bank creates 900 dollars that does not exist and lends it out to others with the knowledge that it is in everyone’s intention to pay the bank back.

In current day , money has completely transformed almost going completely paperless. Every store or business now owns an electronic merchant which basically allows a person to pay for virtually anything with funds that exist or are loaned to said person, anywhere. Technology is reaching such great lengths that you can literally pay for a sofa or a television with your cell phone, with an application called smartswipe which basically links a phone to a bank account and therefore allows for purchases to be made. The idea of paperless money is soon to be made a reality.

Bibliography

• Robert, Murphy. The Fraction Reserve Banking System Explained. The Market Oracle, 2009. Web. 09 Jan 2011. <http://www.marketoracle.co.uk/Article20300.html>.
• Kinds of Money. Investments and Incomes, 2011. Web. 09 Jan 2011. <http://www.investmentsandincome.com/money/money_types.html>.
• History of Fiat Money. Kwaves.com, 2010. Web. 09 Jan 2011. <http://www.kwaves.com/fiat.htm>.
• Selgin, George. Gresham’s law. University of Georgia, 2010-02-01. Web. 14 Jan 2011. <http://eh.net/encyclopedia/article/selgin.gresham.law>.

• Robert, Murphy. The Fraction Reserve Banking System Explained. The Market Oracle, 2009. Web. 09 Jan 2011. <http://www.marketoracle.co.uk/Article20300.html>.
• Kinds of Money. Investments and Incomes, 2011. Web. 09 Jan 2011. <http://www.investmentsandincome.com/money/money_types.html>.
• History of Fiat Money. Kwaves.com, 2010. Web. 09 Jan 2011. <http://www.kwaves.com/fiat.htm>.
• Selgin, George. Gresham’s law. University of Georgia, 2010-02-01. Web. 14 Jan 2011. <http://eh.net/encyclopedia/article/selgin.gresham.law>.