For something so central to everyone’s lives, its surprising that we do not have a more solid understanding of money. It defines the difference between our own wealth and poverty. We literally give our lives in exchange for this medium, which we can then use to exchange for our needs and desires as we see fit. The idea of money has not existed forever; it slowly developed as humans begun to rely on others to acquire their resources for them, while they provided one type of service in return. Similar to focusing on just cooking one dish for a potluck instead of preparing a whole meal, the advantage of this method is people can focus on acquiring one set of skills, tools and resources, and share a high quality product with others in exchange for other people’s goods.
Value of Goods & Services
What is Money
Difference Between Money & Currency
Historical Currencies & Banks
Silver, Gold & Other Important Rocks
Coins & Bills
Modern Currency
Value of Goods & Services
You are a rural farmer, and you recently purchased livestock, and would like to make a fence. You have plenty of trees on your property, but your axe recently broke, and need a new one. The concept of money hasn’t really developed yet, so to acquire something new, you normally trade your goods. You grow grains for a living, and haggle with the blacksmith over what you both agree to is a fair deal for the value exchange. But what happens if the smith doesn’t need any grain, but rather needs copper from a miner for their smelting? You or the smith would need to find a miner who had copper and needed grain. As the number of people you would need to trade through to get what you need increases, the inconvenience, and imperfections of this method comes further to light.
How do you know the value of something in the first place? Could I give the smith a small bag of grains instead of a big one for an axe? To understand the concept of value, we can model it with the following formula:
It is a sum of the value added by the worker, to another Cost. This Cost is any other initial values of things that other workers have added that necessary for our worker to purchase to add their value. Examples include things like raw materials, tools, and replacement parts used for cleaning/maintenance. The value of the tools & parts would be split across the use they get over their lifetime. The value added to this, is the amount of time it takes to prepare/deliver it, multiplied by the skill level required to complete it, multiplied by the demand for it, and divided by the supply availability of the thing. For example, the cost of paying a doctor is high because it requires a high skill level that can only be obtained after years of study, there is high demand for them, only a small number of them available, and their equipment also requires a lot of time and expertise from other professions.
What is Money?
Money is supposed to be the value we defined above, which is used as a medium to exchange for other goods and services. In other words, assuming that the variables in the formula stay the same, the numerical value of the money should stay the same. For example, if a loaf of bread costs one unit of money, and the baker & farmers are using the same processes & tools 20 years later, with consistent maintenance cost & crop growth throughout, then a loaf of bread from the beginning to the end of the 20 years should still cost 1 unit of money.
In addition to being fungible as described above, ideal money is also divisible. If a cattle costs 1 unit of money, and I would like to buy 3, but only have money in the form of 20 units, that change of 17 units can easily be provided in a convenient form that everyone can recognize as 17 units of money. This is instead having to do a full on trade, and accept 17 more cattle or other substitute.
Money is a layer of abstraction that we, as humans have created as a representation of something. It’s not something we could easily express or share with an intelligent animal (like a dog or bonobo), like we can with things like communicating, feelings, and food. If you don’t understand what I mean, country borders are another example of an abstraction we have created. There wasn’t a line drawn in the ground we used, we just kind of said, let it be so, and it was.
Difference Between Money & Currency
Another thing that I would like to clear up is a common misconception many people have. What most people mistakenly call money, is actually a currency. A ideal unit of money will be able to buy me the same product now, as it would in the future.
Currency on the other hand, represents money in a different way that money represents value. Currency is basically the specific numerical value of that medium you assign to things. The numerical value of currency that represents one unit of ideal money, can change though. So what do I mean by that?
Consider again the value of a normal loaf of bread, which humans have eaten throughout their history. The process for making it, and growing the ingredients hasn’t changed drastically, and if anything, industrial baking & farming has gotten notably more efficient than previous small town bakers/farmers from earlier in time, so those numbers in the equation should be smaller. The cost of making bread has never been cheaper, otherwise the industrial companies making the bread would still be using doing what classic bakers did, and have perhaps an oven for every baker they hire. But as we observe and hear from our parents, prices of things have been going up consistently since they were young, and you can no longer purchase a loaf of bread for a few cents.
If 100 years ago, it takes a taxi driver 5 minutes worth of pay to afford a loaf, and we assume the value of the taxi driver’s service and bread remain more or less the same (same supply, demand, skill, time, initial/operating costs), then ideally the amount of currency would be proportional throughout the years regardless of things like inflation. For example, if bread costs 15¢, and the driver earns $1.80/hour earlier in the century, and now bread is $1.50, but the taxi driver makes $18/hour, then the amount of money required to purchase a loaf of bread remains the same, but the amount of currency required has changed.
Another example is the exchange rate between currencies. $2 CAD right now can be exchanged for about £1 GBP. They are different numerical values of currency, but they are the same amount of money. If this makes more sense to you, think of money more as an ideal ratio that doesn’t change between two things; similar to a barter. While it may not be obvious now, this distinction will be critical in understanding other concepts later on.
Historical Currencies & Banks
At least 11 000 years ago, grains and cattle were used as one of the first types of currency [2]. Things that we may consider as goods today, such as certain shells, beads, pelts, rocks, metals… even playing cards, among other things have been used as currencies in the past [2]. What determines whether something is a currency vs a good, is what a group of people agree to use as their medium for exchange. Merchants in different countries will often only accept their local currency, and refuse my dollars for the same reason they might deny me using cattle to pay. A large enough group has agreed on their value, which is then used as the medium for exchange, and using anything else would be inconvenient to have to exchange, just like the bartering example mentioned at the beginning.
Eventually people figured out they could make interest on their wealth by loaning it out. Grain was one of the first examples of this, where a person such as a merchant in possession of extra seeds, would lend them out for the season, with the promise that they would be paid back at least the same weight when the crop was harvested [2].
Storing, and carrying around these large amounts of grains, metals, etc… is not ideal though; they’re heavy, take up a lot of space, and make the owner easily susceptible to robbery. Outside of those who could afford to safely store their wealth in their home, temples were among some of the first places common people would store & access their funds.
These two ideas eventually converged, where institutions could store and be lent wealth, however the issue of keeping track of everyone’s stuff became difficult. Who owes what, how much do you have stored here? Receipts & promissory note (IOUs) were ways of dealing with this, which promised in trust, that you borrowed or lent money. Receipts (paper currency) started off in China, and eventually spread to Europe where it picked up popularity about 1000 years later.
Silver, Gold, & Other Important Rocks
While other currencies have been used for various extended periods of time in history, gold & silver became, and have been the two main metals used for trading goods throughout human history, until very recently. The total amount gold and silver in the world is finite. Unless created as a byproduct in a reaction, or you happen to be an alchemist, you cannot just create it out of thin air. Why was silver, and especially gold chosen worldwide as the standard for money? Ideally money is durable, portable, fungible, divisible, and stores the same value indefinitely. In terms of the choice of metal, I refer you to the following video of periodic table bingo.
Something to note: while rust and tarnish are both forms of corrosion, they have different effects. Tarnish is self-limiting, in that once an object is covered, it serves as a protective layer against further tarnishing, where-as rust is not, and will continue to spread throughout the metal. So while gold was an ideal metal to use, silver remained a close second, especially since it was more divisible. Other metals like copper, nickel, and tin are good runner-ups to these two, and were used as currency as well, although were not as popular.
Coins & Bills
Now you have all of these different sizes, colours, and weighted metals in your coin purse. To help address issues of consistent value and assurances of quality & authenticity, these metals were smelted into coins, some with hard to reproduce stamps of their king to also aid in these issues. These coins were often an alloy with >90% purity. The United States had silver dollar coins with this amount of silver for awhile too. Precious metal coins sold today in Canada and the States still require 90–95% purity by law, depending on the metal.
Receipts of credit in your bank, evolved into dollar bills. Like a receipt, a bill was originally a promise that you held that value of gold/silver somewhere, and it could be redeemed to someone in exchange for that, or used to trade for another good or service.
Modern Currency
Where currencies are now, is a more complicated query, but we’ll connect the dots from then to now. The gold and silver standards are a monetary system, in which the standard unit of currency (in this case, a silver dollar) is a fixed weight of gold/silver, like the bill above represents. As you may of noticed, modern bills no longer say this on them, and coins are often made with cheaper metals. This is because most of the world left the gold & silver standards mostly around 100 years ago.
What does this mean for consumer though? You can no longer redeem the equivalent amount of silver promised in the dollar bill above, with a single USD. Same thing with an equivalent dollar coin. As a result, this meant that they had to use cheaper metals so that the value of the materials used were less than the value of the currency. Here in Canada, pennies are no longer in circulation because even after removing many valuable metals from coins to make them cheaper to produce, the penny eventually grew to be more worthless than the value of the metals they were made of. Currencies today can be thought of now as rare trading cards. Unlike before with silver and gold, the value of the raw materials in today’s currency aren’t as expensive as the value we place on them, its just what people will exchange for them. This phenomenon is called inflation, and it has a lot of implications on currencies, and the worldwide monetary system.
