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The Concept Of Money...From Past to Present

Updated on December 28, 2011

The Four Functions of Money

Money in its inception served primarily four functions; they were as follows:

1. Medium of exchange. Money is used as a kind of in-between (middle ground) to facilitate the exchange of goods and services. In essence, it’s being used to help streamline the trade process; which, of course, is very pertinent to an efficient flow of goods and services in a free market economy.

2. Store of value. Money that doesn’t get spent must be readily able to be saved, stored, and retrieved; this same stored money most then be ready to be used as a medium of exchange if deemed necessary in the future. This said, the value of this stored money must also remain stable over time—inflation (overall rise in prices) must neither reduce the value of money, nor diminish its ability to function as a medium of exchange.

3. Unit of account. Maybe the biggest benefit to money is its ability to function as a unit of account. Instead of having a coincidence of wants, money now represented a standard numerical unit of measurement for the market all valuable goods and services. To function as a unit of account, the tangible item that is being used as money must be:

· Broken down into smaller units without loss of value; precious metals can be coined from bars, or melted down into bars again.

· Fungible: that is, one unit or piece must be perceived as equivalent to any other.

· Specific weight, or measure, or size to be verifiably countable.

4. Unit of deferred payment. What this means is that money that isn’t immediately needed could be lent to others, gaining interest and financing projects that provides a return to society; which, of course, if you’ve ever applied for a bank loan, you should understand this function of money.

To facilitate efficient transactions within an economic engine, the functions of money must make possible both the benefits of specialization and division of labor. Through these four functions (medium of exchange, store of value, unit of account and unit of deferred payment) our economic society has been able to experience great human avarice and social prosperity. How important is the value of money? In a market based economy, money is used as an economic barometer: things like job salaries, school tuitions, house values are all stated in terms of money. This said, as a kind of perpetual caveat within the boundaries our economic society, the value of money is only as good as its purchasing power. What’s purchasing power? Purchasing power is considered the real value of money and refers to the amount of goods and services that can be purchased with a certain amount of money. The reason why it’s so important—in reference to the functions of money—is because if the price level changes it tends to change the purchasing power along with it; which is why it’s not a bad idea to back money with some kind of commodity.

Money: Where Did It Come From?

In its inception, money had very little to do with government, which shouldn’t strike many financial pundit as a complete surprise; after all, the history of money is as colorful as the history of ancient man/woman itself. The genesis of money started out pretty much as any other tradable tangible item, however, in the case of money, it became the one thing that all other goods and services were traded for. As society started advancing, so did the need for a kind of “middle ground” tradable good. This said, the concept of money became anything a chosen community, collectively, decided to give this “middle ground” distinction to. In fact, in certain primitive communities— especially throughout the Americas, Asia, Africa and Australia—things like shells were used as money. From primitive communities we moved to a more agrarian lifestyle, one in which necessitated the need for the exchanging of goods for one another. This came to be known of bartering.

Bartering: First Form of Medium Of Exchange

Under a bartering type environment, the production of marketable goods was produced by those who specialized in certain products. Specialization is a very interesting concept in economics—its existence brings about the powerful economic doctrine of division of labor. Specialization did three things: 1) It permitted individuals to take advantages of existing differences in their abilities and skills; 2) It allows individuals to learn from their mistakes (trial by error); and more importantly 3) It avoided the loss of time involved in shifting from one job to another. These three things, in reference to medium of exchange, created a prerequisite of specialization—which then perpetuated the need for bartering. At the bare minimum level, to barter something just means to swap a good for another good—a genial idea if you stop to think about, but bartering as a true form of money was very limited. When a person barters something, he/she is giving you what they have in abundance—that is to say, he/she engages in trading what’s considered “specialized leftovers.” That’s pretty much what bartering mean: “give me your specialized leftover, and I’ll give you mine.” But at what price?

The beauty of swapping one good for another good created a kind of “gain/loss” ratio. If one side experienced a gain from the swap, the other side had to experience a loss; therefore, there was never a need to place a price on a good. It was pure voluntary free market economics at its best—undisturbed, mutually beneficial for both parties and rather efficient for those days and times. But here’s the thing about using the bartering system as a medium of exchange: the “tradable goods” system relied too much on specialization. If the bartering system created one major area of limitation, it was the magnitude of exchangeable goods, which impeded the level at which production could grow. In the book Macroeconomics by authors Campbell McConnell and Stanley Brue, this phenomenon, albeit tacit in nature, is described as a coincidence of wants. For example, if a tomato farmer wanted to get himself a new suit, he would have to find a tailor at that particular moment that wanted his tomatoes; otherwise the exchange or barter couldn’t take place. What if the tailor already had a bunch of tomatoes; why would he want tomatoes just for the sake of satisfying the tomato farmer’s needs? Bartering a good for another good is as old as the concept of money itself, but its limitations far “outweighed” its advantages.

In contemporary times (with all the technological advances), we’re beginning to see a resurgence of bartering as a medium of exchange. Through sites like Craigslist— with its millions of users—the limitations of bartering becomes less of an issue: the idea that one guy might want to swap an alligator wallet for socket set increases as more users frequent the site. This wouldn’t be possible in a small bartering community. Again the two parties would be limited by their coincidence of wants. Here in lies the beauty of our current money in use today—that is to say, humans realized that in order to overcome its bartering limitations, there had to be something of value that we all agreed had the same intrinsic value and could, simultaneously, satisfy all our needs and wants—that something was the birth of what we now consider to be money.

Gold And Its Embryonic Stages

If anything can be money, why not gold? At least that was the prevailing consensus back then. In fact, gold, a commodity, proved to have great advantages as a monetary unit: 1) Its supply was limited; therefore, it was considered precious; and 2) Because of its mass appeal by the monarchy, it was always in constant demand. As a precious metal its price level tended to always be stable. Furthermore, the early use for gold as money was born out of necessity more than anything else. Because it was easily recognizable, it could be divisible into small units and it didn’t have a problem with wear and tear. This said, the appeal to it as a form of money made perfect sense—perfect sense in the “sense” it was one of the very few raw materials that satisfied the four functions of money listed above.

As economies became more progressive and started modernizing, precious metals (namely gold and silver) became a very attractive option. Why not other metals— i.e., copper, aluminum, etc? Well, the answers to those questions were quite simple: they weren’t attractive enough to warrant outright demand. Gold had a very bright color, great mass, but wasn’t too bulbous and heavy. Also, more importantly, it neither faded nor rusted away. Let’s not forget that, it was malleable and could be easily made into fine jewelry. These distinguishing features made gold a perfect candidate for becoming a monetary unit and paved the way for the U.S. adopting a gold standard, which is a monetary system in which a fixed weight of gold becomes the standard economic unit of account. From the establishment of the gold standard, we then started witnessing the emergence of the U.S. banking system.

Commodity Money System Is The Only Solution

The bad news is we’re in a financial crisis. The good news is that there are solutions to the problems that plague our economic society. Let me put it this way, fiat money, since its inception has put a veil over our eyes and doesn’t allow us to see the real errors of our ways. Can an economy grow from real money or fake money? The economic logic of this question seems trivial, indeed, but remains at the heart of our current economic engine breakdown. In historical review, money that was backed by something of intrinsic value (gold, silver, etc) has always been the catalyst for major economic growth. On the other hand, money that wasn’t—we’re finding out the hard way—was a precursor to a financial crisis. All the same, if any robust economy aspires to grow, there’s little alternative to a commodity money system; which, of course, is a money system backed by some form of commodity. Commodity money is real money! And to be quite honest, it’s money that we don’t currently have in existence.

On the other hand, fiat money is “paper money” and it’s about as good as that fake monopoly money we used to play with as kids; hence the term “paper currency.” Does fiat money have value? Sure it has value, but what gives it value isn’t the kind of value that’s sustainable for in the long run: what gives it value is solely, the concept of a growing economy, thus fiat money is backed only by a concept. Sure you it can be used to purchase goods and services in an economy in the short-run, but what’s going to happen to a currency in the long-term when an economy stops growing? This is something to, at least, ponder—because this question begets one of the most powerful concepts in economics: that’s called monetary purchasing power. In other words, you want a currency’s purchasing power (the ability to buy things) to grow in accordance with a growing economy. This will never happen with fiat money because “big gov” has the ability to play with it too much, thus, overtime, fiat money becomes significantly less of a means of payment. Fiat money, as a concept, is based on an economic fallacy.

To use my “money tree” example, any good economy wants its money to be planted on solid ground. Therefore, the dollar bills that grow from its branches are rooted in something tangible. Today’s monies are like detached leaves, flying around, thinking that it’s apart of the tree but it’s really not. To a fool walking by, noticing all these dollar bills—he may pick-up a money leaf, put it in his pocket and think that he has something of value—only to arrive at home with a rotten bill. This type of scenario is being played out all over America: “big gov” is painting an elusion that our money has real value when, in essence, it’s a dying bill. How did we arrive at such a state of monetary madness? Well, to start with, our problems began a long time ago and have been spiraling out of control for years. Ever since Nixon took us completely off the gold standard in 1971, our monetary system has been—over the decades—slowly deteriorating. Because commodity money doesn’t allow monetary system distortions, the gold standard was a very powerful tool within the parameters of free market capitalism. The brilliance of making gold a monetary standard was primarily to avoid outside free market influence.


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