As a civilization, we are in a constant state of want. Whether an ice cream cone or a yacht, money is the means for us to obtain what we desire. It consumes our thoughts and influences our decisions. Times are good when we have an abundance of money. Yet, it is a source of anxiety when we lack it.
Where did the concept of money begin? When was paper money first used? What is fiat currency? In this article, we will find the answers to these questions.
Barter and Trade
Before the idea of currency came into existence, people would barter what they had for what they needed. If a person had plenty of chickens and wanted cattle, they would trade a certain number of their chickens for an equal value of cattle.
This system worked well in small societies, but problems soon erupted. As society grew, it was hard to track what was bartered and to whom. Also, the number of barterers increased, leading to a need for a medium of exchange, an IOU.
Grains, Seashells, and Whale’s Teeth
At first people used items like grains, seashells, or whale’s teeth. These objects would represent the value of the items they purchased. Yet, even this caused problems. Sacks full of grain would be heavy to carry and not durable. Shells were plentiful if you lived near a beach. Whale’s teeth, though scarce, were hard to break into smaller pieces for their fractional value.
Emperors found a way to create currency using precious metals. Gold and silver were used for their intrinsic value. They were able to melt and mold them into coins. Usually, the face of the emperor would be on the coin, along with his title.
Unfortunately, the emperors found ways of mixing other metals into the coins, and this cheapened the value to the point where the metals were worth less than the amount printed on them.
Around 1000 A.D., the Chinese developed a system to issue promissory notes. They realized hauling sacks of gold long distances could be cumbersome. Therefore, they printed notes on paper with a promise to pay. The buyer would give the seller a note. The seller went to where the gold was stored and traded the note for the amount of gold due. This became known as the gold standard.
It wasn’t long before other civilizations followed suit and printed their own money. However, it had to meet three criteria: scarcity, value, and portability.
Scarcity: To control the prices of goods, the currency had to be scarce. An overabundance would lead to hyperinflation.
Intrinsic Value: The amount of paper money to be printed had to represent the total value of gold the society possessed. The purpose was to trade the money in for its weight in gold.
Portability: It had to be easy to carry when making expensive purchases.
For most of the second millennium, countries maintained the gold standard. This was to keep the government from printing extra money, which would cause devaluation. For example, let’s say that a government owned one million dollars worth of gold. They print one million paper dollars, each worth only one dollar. If the government decided to print another million paper dollars, then the value of each dollar would be cut in half, reducing its buying power.
The gold standard continued in the United States until the early 1970s. President Richard Nixon decided to take the dollar off the gold standard. This created fiat currency. The dollar was backed by the US government’s promise to pay.
Without gold backing, governments could print as much money as they wanted. Unfortunately, it lead to debt, known as deficit spending. Many governments acted without restraint, leading to hyperinflation and a collapse of the economy. A good example would be the Weimar Republic of Germany in the early 1920s.
Only two percent of all transactions are in paper currency. Most Americans either pay by credit and debit cards, smartphone apps, or digital currency. Once the buyer makes a purchase, the bank automatically deducts the funds from the account. Payment is instantaneous—no need to handle cash.