What is Money? Free Markets Explain History

The WealthCycles Staff

What is money, and why does it matter what we use as money?

First of all, if we simply use paper rectangles as money, they can be printed. The government or, in the case of most modern nations, a bank can print as many new rectangles as it sees fit to suit its purposes. As the supply of currency increases, the price of goods and services goes up, because each new paper rectangle created means each paper rectangle already in existence is worth less. Each unit of newly printed money can purchase at present prices, but money in existence prior to the printing must buy goods and services at the new, higher price level. This permanent, ongoing and silent taxation robs everyone, but affects the poor with the most relative brutality, making the so-called “War on Poverty” a cruel joke at best.

If the poor all over the world just knew what medium, what type of money to save in, they could avoid this loss of purchasing power and save in a way that would improve their standard of living. The great thing is—the vast majority of the world’s people do already understand this concept and actively save in silver and gold coin. But are silver and gold coin really money?

There are two arguments on the origin of money. One is the argument of a centralized state and its supporters who insist that money was thought up by a government or some central authority and should be controlled and institutionalized. Another is the argument—the truth—that money spontaneously arose through multiple, concurrent processes of elimination, during which individuals sought an ideal medium of exchange to facilitate indirect trade.

Dr. Robert Murphy finds it hilarious that “even the harshest critics of the Mengerian account of the origin of money, end up relying on anthropological evidence that is in total agreement with his [Carl Menger’s] story, and makes little sense with the rival State narrative.”

To make his point, Murphy gives the example of the following extraordinary passage from Ambrose Evans-Pritchard:

It is a mythinnocently propagated by the great Adam Smiththat money developed as a commodity-based or gold-linked means of exchange. Gold was always highly valued, but that is another story. Metal-lovers often conflate the two issues.
Anthropological studies show that social fiat currencies began with the dawn of time. The Spartans banned gold coins, replacing them with iron disks of little intrinsic value.

If one bans gold coins, gold coins had to have existed first, and yes, they were used as a means of exchange—or as money, just as Smith stated. Wow, quite the excursion from logic.

Yes, gold and silver coins were debased and eventually were composed entirely of iron so there would be more coins to spend, even as their purchasing power fell. Iron coins could be produced in increasing quantity, whereas silver and gold, because their quantity was limited, afforded no such luxury to the aristocracy.

But Murphy hits on something more subversive when he cites the “rival State narrative,” as Evans-Pritchard seemed to support.

The false claim is put forth and promoted that money is a social contrivance. History shows the opposite: money results from human action rather out of human design. Here is an example Murphy gives to exemplify the statist position, from none other than economist Paul Krugman:

So what is fiat money? It is, as Paul Samuelson put it in his original overlapping-generations model (pdf), a “social contrivance”. It’s a convention, which works as long as the future is like the past. Obviously, such conventions can break down — but then so can things like property rights. In fact, you could argue that almost every asset in a modern economy owes its value to social convention; green pieces of paper could become worthless, but then so could any paper claim, which is, after all, worth something only because laws say it is — and laws can be repealed.

Murphy says that Krugman is making it sound like fiat money has its value for the same reason that people generally hold doors for each other, recalling a similar position held by another statist:

Fundamentally, money is just a social convention. I agree to give you my stuff in exchange for your intrinsically useless money, but only because you agree to do the reverse in the future.

Now Murphy suggests the question crushing the totalitarian desires of the statists: “But how could such a money come into existence? After all, self-interested individuals would be very reluctant to surrender real goods and services in exchange for intrinsically worthless pieces of paper or even relatively useless metal discs.”

He adds the following, which also explains why demand for silver and gold money reaches infinity:

It's true, once everyone else accepts money in exchange, then any individual is also willing to do so. But how could human beings reach such a position in the first place?

According to classical economics, as Carl Menger would explain, money emerged spontaneously through the self-interested actions of individuals. There is no historic record of a single person sitting back and conceiving of a universal medium of exchange, even though money was used in all ancient civilizations.

People valued gold for its own sake before it became a money. Murphy explains:

In order to understand how this could have occurred, Menger pointed out that even in a state of barter, goods would have different degrees of saleableness or saleability. (Closely related terms would be marketability or liquidity.) The more saleable a good, the more easily its owner could exchange it for other goods at an "economic price." For example, someone selling wheat is in a much stronger position than someone selling astronomical instruments. The former commodity is more saleable than the latter…
The point is that the seller of a telescope will only be able to receive its true "economic price" if he devotes a long time to searching for buyers. The seller of wheat, in contrast, would not have to look very hard to find the best deal that he is likely to get for his wares.

Owners of relatively less saleable goods will exchange their products not only for those goods that they directly wish to consume, but also for goods that they do not directly value, but are more marketable, so that these goods can be used as money in indirect exchange.

Along with silver, gold was indeed highly valued throughout “the dawn of time,” as Evans-Pritchard noted. This is and was due to the natural traits of the precious metals combined with their relative scarcity.

Unfortunately for us, multiple generations have ascribed value to irredeemable banknotes, but notice that originally the notes were redeemable; they were exchangeable for real money—silver and gold coin. The dollar is not the banknote, the issuing bank took the name. Below we see a redeemable banknote, and the money it could be swapped for as paper notes merely represent a "claim check" on the real thing. The $1 is silver.

Let us sum up the origin of money with this list of traits compiled in The Dow Theory Letter, published continuously by Richard Russell since 1958.

(1) It must be durable, which is why we don’t use wheat or corn or rice.

(2) It must be divisible, which is why we don’t use art work.

(3) It must be convenient [portable], which is why we don’t use lead or copper.

(4) It must be consistent, which is why we don’t use real estate [or diamonds]

(5) It must possess value in itself, which is why we don’t use paper.

(6) It must be limited in the quantity that is available, which is why we don’t use aluminum or iron.

(7) It should have a long history of acceptance, which is why we don’t use molybdenum or rhodium.

Mike Maloney urges the correct use of the terms money versus currency / banknotes. Gold and silver are money. Money is a store of value over a long period; paper cannot and has never achieved this attribute. For more on this topic please enjoy the lecture below:

On the history of money and currency, the Canadian dollar was one of the most popular currencies of the year. It seems to have been devalued some recently. Some references on this: loonie currency chart and devalue information.

Bitcoin became money in may 2010 when it moved from being a valueless re-titleable ledger entry to being something you could get someone to buy you a pizza with. Amazing stuff.

Any form of money created by man can be abused by man. The vulnerability of web-based money? Governments are known to attempt to shut down internet access when truly threatened (Egypt).
I appreciate the creativity of the bitcoin idea, but I still prefer to hold money that can't be devalued, in my hand.

Bookmark and Share

Related Content