Economics for Ordinary People
What is Money?
A Very Brief History
I’m an ordinary person interested in Economics. This article is part of a series, where I try to explain Economics in a way that ordinary people might understand. I start with Money — probably the most important and least understood concept in economics.
Money 0.0 — Barter
In the beginning, humans mostly bartered.
Suppose a farmer produced rice, and a fisherman caught fish. When the farmer wanted some fish, he could give the fisherman some rice and, in exchange, get some fish. This type of exchange is known as barter.
Barter allowed humans to perform transactions before the invention of money. Hence, barter was a sort of “Money 0.0”.
How much fish was exchanged for how much rice? This depended on how much of each was produced (“supply”) and how much of each was needed (“demand”).
Money 1.0 — Salt, gold and other objects
As time went on, some items appeared in barter transactions more often than others.
For example, when the farmer needed some fish, he would exchange some salt instead of exchanging rice with the fisherman. When the fisherman wanted some rice, he would then re-exchange some salt, with the farmer, for rice.
It was easier to exchange salt or metals (like copper, silver or gold) because they were more durable than perishables like fish or rice. The fisherman could store salt or gold until the farmer’s harvest was ready. Fish, on the other hand, might have gone bad.
In this way, salt, gold and other objects became the first type of money.
How many grains of salt was a sack of rice or a fish worth? As before, this depended on the supply and demand of rice, fish, and salt. In this respect, the money was no different from the goods exchanged.
Money 2.0 — Promissory Notes
Carrying around precious metals like gold or salt was problematic. Several bars of gold could be heavy. Hence, institutions like banks started to replace “Object Money” with paper money in the following way.
The bank (or other organisation) would issue a piece of paper, which said something like “We promise to give 1 gold sovereign, in exchange for this” printed on it. Since it carried a promise, these pieces of paper were known as “promissory notes” or simply notes. Hence, you could buy anything worth 1 gold sovereign with this note because the seller could then take the promissory note to the bank and exchange it for a real gold sovereign.
A promissory note was a sort of “I owe you”. When the bank gave someone a promissory note, they owed that person real money. Hence, the bank had to own enough real money to pay off their promissory notes.
Money 3.0 — Fiat Money
What we know as money today is “Fiat Money”. Almost all modern countries use Fiat Money.
Unlike Money 2.0, Fiat Money is not tied to anything real. Like gold, there is limited supply of it because only central banks can print them. Also, like gold, they don’t have practical value (you can’t get any nourishment by eating gold). They have value only because everyone else thinks they are valuable (like gold). In this way, Fiat Money is a sort of “artificial gold”.
What Next?
I kept this article “Very Brief” for two reasons.
The first reason: The shorter the article, the more readers, and I wanted as many people to read this article (and hopefully follow-ups).
The downside of a “Very Brief” article is obvious gaps. Many questions are left unanswered. Paradoxically, this was the second reason. I want you, dear reader, to think carefully about what I’ve said, and what I have not said, and ask as many follow-up questions as you can.
Questions like,
- How do supply and demand inform prices?
- You said only governments can print Fiat Money. How much money should they print? How much is too much?
- You said Fiat Money has no practical value and that people have to believe that it is valuable. What happens if they stop believing?
- Can anyone issue money? Just like non-banks issued promisery notes in the past?
- Where does crypto-currency fit in? Is it Money 2.0, 3.0 or 4.0?
I hope to answer these and others (of which, hopefully, there are many) in follow-up articles.
