The Origins of Money

One of the things that I was never taught in school is what money actually is- i.e. it’s origins, etc. I guess I always thought our country just decided what color its paper bills were going to be when George Washington moved here. Kinda selfish to put your own face on there, George. But alas, that’s not it. Money actually came from somewhere!

The Origins of Money

The Barter System

Whenever there are several people in one place for the first time and they figure out that other people have stuff that they would like to have, they tend to trade their stuff with each other. This happens among grade school kids. I have Jell-O, you have a Snack Pack…boom. Even trade.

A better example: three farmers- a wheat farmer, an egg farmer, and a dairy farmer. The wheat farmer needs milk and eggs, and he can easily trade with the milk or egg farmer a bushel or two for a gallon of milk or a crate of eggs. Boom. Barter. Seems like that should work for everybody, right? Nope!

Problems With Barter

A Double Coincidence of Wants

Barter is working so far, because it seems like everyone wants what everyone else has and will trade for it. One of the essential ideas that makes barter successful is called a “double coincidence of wants:” when one part wants what another party has and the other party wants what they have…at the same time.

Our first problem arises here, very quickly, in the barter world. As it turns out, the egg farmer is allergic to dairy. He is unwilling to trade for it since he’ll never use it, so the dairy farmer is out of luck for the moment if he needs eggs. Barter fails here.

Our dairy farmer knows something valuable, though: the egg farmer likes wheat! So what does he do? He trades his milk for wheat from the wheat farmer in order to trade wheat (instead of milk) for eggs. Boom. Money.

What I mean is: for the first time in this farming, bartering society, we have a commodity that is acquired without concern for consumption, but rather for transaction. In this case, wheat has become money–a medium of exchange. Without going too far for now, we have to realize that not everyone will want wheat…so to solve the problem for good we’ll have to find something that will be universally desirable as much as possible.

Divisibility

Another necessary factor in a successful barter scenario is divisibility. A dozen eggs for a gallon of milk can easily be divided into 6 eggs for half a gallon. That totally works. But not for long.

Enter the guy that sells trucks. Good old farm trucks. What happens when this guy needs eggs? With barter he would have to buy 5,000 dozen eggs. Yes. 60,000 eggs. Two problems: he doesn’t want that many eggs, and the egg farmer doesn’t have that many eggs. The problem here is that he, unlike the three farmers, is unable to divide up his product. In pieces the truck has no value. Here, again, he needs a medium of exchange- this time he needs one not only that is universally desirable, but one that is both divisible and valuable when divided.

Accountability

The third problem with the barter system is an inability to keep accounts. There is no way to really know if you have experienced profit or loss. Further, as society and products grow more varied and complex, no pricing structure can really be sustained. One hat is worth 3 dozen eggs or 5 bushels of wheat or 4 gallons of milk or 5 crates of blackberries…and on and on.

What we would need is one commodity that is valuable, divisible, and universally desirable with which to engage in trade and to keep account with. It doesn’t necessarily matter what, so long as they meet those natural demands. We would then be able to measure out everything through the one commodity- say forks, for example. One hat is worth 8 forks, as are 3 dozen eggs, 5 bushels of wheat, 4 gallons of milk, or 5 crates of blueberries. Profits and losses, then are measurable, and prices can be set. In this case, forks would be the money.

What Makes The Best Money?

So, just as we had natural problems within the barter system, so the solution of “money” arises naturally. We used both wheat and forks as hypothetical money, but both of those have some shortcomings.

Wheat is only tradable when it is usable for consumption, which poses a slew of problems sustaining it as money. Soon one of two things happen: the wheat is eaten, or the wheat spoils and automatically the money loses its purchasing power. In a drought or a simple off-season, wheat may become so scarce that it can’t be traded at all. So we need a money that is effected by such things as little as possible. Forks face similar problems. Just trust me so that I don’t have to be annoying.

The Best Money

Throughout history, the process of switching from the barter system to a money-based system has happened time and time again. Two metals have actually risen consistently out of the mess–emerging naturally as a preferred money–gold and silver.

Gold (silver, too) meets the demands that form out of our barter problems. It is universally desirable, for the most part. However, that desire doesn’t make it disappear or devalue such as wheat would. Gold is easily divided, but in division still maintains a high value. Gold isn’t subject to rapid inflation, since we would have to dig it out of the ground (as opposed to pushing Ctrl+P on a keyboard). Counterfeiting is easy to spot with these metals. Accounting becomes simple- the weight of gold is its value. 1 gold ounce may buy several different things, but they can all be measured by that weight. Balances can be maintained, profits and losses measured.

Boom. That’s where money comes from.

So…what is a dollar?

Some other time.

Advertisements

4 thoughts on “The Origins of Money

  1. David and I are in the same boat…trying to learn all the stuff that public school forgot to teach us… At least we have Hayek and Mises!

    It is amazing how simple “money” is… And that the word actually means something!

    Great insight, David.

  2. Loved this post, David! In fact, I just read it to my 9-year-old, Will, as part of our homeschooling lesson and he loved it. We were reading in Matt. 17 about Jesus and Peter paying their taxes and we got into an interesting discussion about taxes, government, and money. I had read this last night and it fit right in. I always think the test of whether you have a firm grasp on a topic is if you can explain it to a kid! Thanks!

  3. Wow- awesome reply, Tanya. I’m hoping to do much more with Economics topics, and I think I’ll make sure I can explain it to a kid before I write it down. What a perfect guideline for me going forward.

Whaddya Think?

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s