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Posted over 1 year ago

What is Money and Where did it Come From?

Though we all use money on a daily basis, the knowledge we have about the subject in most cases would barely scratch the surface. Below is a short summary of the history of how we moved from a system of bartering to one of using paper bills.

The US Government Can’t Define What Money Is

Sometime in the last century, a man noticed that on a $10 bill there was a statement that the bill was redeemable for “lawful money”. He asked the US Treasury if the dollar bills he was carrying around are then not “lawful money”. The then Acting Treasurer wrote back to him that “the term ‘lawful money’ has not been defined in federal legislation”. By 1964, the phrase “redeemable in lawful money” was removed from US currency.

A Medium of Exchange

Historically, people used to use the barter system where they would trade for things they wanted and needed. In time, it became clear that certain items were more frequently traded for than others and so if you had an item that was harder to trade (something fewer people wanted) you might hold on to an intermediary item. For instance, not everyone wanted an anvil, and so a blacksmith might stock up on something else like grains that were more popular, knowing that it would be easier to trade those grains for something else.

Those items that were the most popular and frequently traded became a medium of exchange, and the first real “money”. It was something that took the place of bartering and made trading easier. Similarly, walking around with a bunch of anvils or cows is cumbersome, but carrying around something smaller and lighter to trade is easy.

Metals as Money

Most people know that we used to use metals such as silver and gold as currency. This is because the metals were easy to carry, they didn’t perish like food, their size could be manipulated to create smaller and larger denominations, and they were deemed attractive for non-monetary reasons (i.e. people already saw their value for things such as jewelry).

Once gold and other metal coins became a standard currency or medium of exchange, people began to desire more and more of it. Merchants and kings alike began “coin clipping”, or shaving off tiny pieces of their coins and using those clippings to make new coins.

What’s interesting is that even though the public may have been unaware that the king was clipping the coins they paid as taxes, and increasing the money supply, market forces made it such that it didn’t matter. With more coins in circulation, each coin had inherently less value. What used to cost ten coins might now cost twelve. This was the beginning of inflation.

Receipt Money and the First Bankers

As society grew and expanded, people began to not want to carry around heavy coins all the time, especially if they knew they didn’t need to spend them all at one time. They wanted a safe place to store their coins where they wouldn’t be stolen.

Goldsmiths already had strong vaults as it was their job to handle large amounts of precious metals that they needed to keep secure. So, it shouldn’t be a surprise that people sought to borrow vault space from the goldsmiths (for a fee of course).

When the goldsmith accepted coins from an individual, they would be issued a receipt. That is, they were given a piece of paper confirming how much they had in the vault (not unlike a modern-day bank that tracks what you have in your account). When someone wanted to make a purchase, they would simply visit the vault and take out the necessary amount.

In time though, people began to walk around with smaller receipts, instead of simply one with their entire balance. This allowed you to go to the market and buy something on the spot by handing over one of your receipts to the merchant instead of first going to the vault to make a withdrawal. The merchant would then collect several receipts and at the end of the day, go to the vault to turn in all the receipts given to them by their customers. This system eventually led to the modern-day check, where you allow someone else to withdraw a precise amount of money from your account.

As people began to trust the system, knowing that these paper receipts were as good as gold, they went to the vault to settle up less and less often. The paper itself had no value, but it’s what that paper represented that made it valuable. The same is true of today’s currency. Green paper with the picture of a president has no inherent value, yet we all know that we can exchange those pieces of paper for the things we want and need. It’s that trust in the system that gives money its value.

Remember the man at the beginning of this article who wanted to exchange a ten-dollar bill for “lawful money”? Having the written offer to redeem that piece of paper for “lawful money” goes back to our goldsmith story. The receipts that were handed out to people by the goldsmiths had printed across the top “Pay to the bearer on demand”. In other words, the goldsmith’s receipt was a promise that at any time anyone holding that receipt could come to the vault and exchange it for an applicable amount of physical gold.

But again, over time people did this less and less. Most of us today, just leave our money in the bank. It’s there when we need it and we don’t feel the need to periodically visit the bank to make sure that it’s still there. In fact, because the public’s trust in the monetary system was so strong the US government was able to take us off the gold standard without destroying the whole monetary system. In other words, we no longer have the option to “go to the vault” or in modern terms, the US Treasury, and exchange our paper currency for gold. Still, the system continues to operate. Of course, there are other consequences of our currency no longer being tied to physical gold.

In the next article, we’ll continue the discussion on money, and explore the how fiat money and printing money led to rampant inflation in the early days of our nation and how the fractional reserve system allows lenders to create still more money leading to even more inflation.