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The evolution of money

March 4, 2024
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FinMeUp
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FinMeUp

The history of money dates back thousands of years

Have you ever wondered how money came into existence? The history of money dates back thousands of years: From the early days of bartering to the first metal coins and eventually the first paper money. 

Money has always had a significant impact on the way we function as a society. In this article, well investigate the history of money and how it has evolved into the systems we use today.

A brief summary of our monetary systems:

  • Barter (<500 BC)
  • Metal coins (500 BC 1650 AD)
  • Paper money (1650 -1850)
  • Gold standard (1850 -1944)
  • Bretton Woods (1944-1971)
  • Fiat (1971 -)
  • Cryptocurrency (2009 -)


Barter (< 500 BC)

Before money was invented, people exchanged goods and services directly with one another. This system was known as the barter economy. In a barter economy, the fisherman would trade his fish directly for the farmers sheep, instead of paying money to acquire the sheep as we do today.

The barter system works on the double coincidence of wants principle, which ultimately led to its downfall and the consequent development of new monetary systems. What if the fisherman wanted sheep, but the farmer didnt want fish? In such a scenario, the fisherman had to search for someone who wanted what he had, and who had what he wanted. 

The other problem was the issue of division and valuation. How many fish is one sheep worth? Is it three, four, or five? And what type of fish, and of what size? And what if the fisherman has three fish, and it is agreed that three fish is equal to only half a sheep? How does the farmer sell half a sheep? 

 

Metal coins (500 BC 1650 AD)

In 600 BE, Lydia minted what is believed to be the first official currency, the Lydian Stater. Staters were small metal pieces made from electrum a mixture of silver and gold. The coins had a fixed weight and value, bearing the official seal of the government.

In 800 AD Rome, the first silver penny was issued which became the standard coin in Western Europe until 1200 A.D. By the mid-13th century, the shilling and pound became widely used to describe larger amounts of pennies. 

 

Paper money (1650 1850)

Paper money was first developed by the Chinese in around 700AD. They called it flying cash, as it had a tendency to be carried away by the wind. When Marco Polo visited the Chinese in the 1200s, he bought the idea of paper money back to Europe. However, paper money only started to see widespread adoption in the Western World in the mid-1600s.

The idea behind paper money is that banks would issue notes that promised to pay the bearer a sum of gold on demand. These notes thus represented value, rather than having value itself. Merchants found it much easier to trade notes with each other instead of lugging around large amounts of metal coins.

Notes could be taken to the bank at any time and exchanged for their face value in metal - usually silver or gold coins. Paper money could also be used to buy goods and services. In this way, it operated much as currency does in the modern world. However, it was issued by banks and private institutions, not the governments as we know it today.

 

Gold Standard (1850 1944)

By the early 1900s, virtually all countries had adopted the gold standard - a monetary system in which the value of money is directly linked to a fixed amount of gold. This meant that the money in circulation was 100% backed by gold: For every dollar in the economy, there was a set amount of gold stored in the banks vaults. 

This system worked great in theory, but it had a pitfall: It meant that notes could not be printed blindly  it could only be printed if the linked amount of gold was stored at the bank. The war and the Great Depression of the 1930s were the final nails in the coffin for the gold standard as the standard simply became too restrictive for governments. Not enough gold means not enough money that can be printed to stimulate the economy.  

 

Bretton Woods (1944-1971)

After WW2, the world needed a new financial system. In 1944, a conference was held in Bretton Woods, New Hampshire.  The US, which held 2/3rds of the worlds gold reserves at the time, was by far the most influential player. It was decided that the dollar will remain linked to gold (at $35 per oz), whilst the rest of the world will be linked to the dollar. The US dollar thus replaced gold as the world reserve currency, essentially making the US the most powerful country in the world. 

The system worked relatively well until the late 60s to early 70s, until the supply of gold once again came under pressure in America. The US started running deficits to fund various projects, and therefore the number of dollars in existence kept increasing whilst the gold reserves in the US kept shrinking. In 1971, the U.S. terminated the convertibility of dollars to gold, which brought the Bretton Woods system to an end. 

 

Fiat (1971 -)

Fiat money is the opposite of commodity money. A fiat system is based on a governments mandate that the paper currency it prints is legal tender for making financial transactions. Legal tender means that the money is backed by the full faith and credit of the government that issues it. In other words, the government promises to be good for it. 

Fiat money in itself does not have intrinsic value. The value it offers is the backing of a central authority that maintains its value and because parties engaging in exchange agree on its value. The public has enough confidence and faith in the moneys ability to serve as a medium of exchange, a unit of account, and a store of value.

The two main drawbacks of the Fiat system:

  1. Centralized: Central banks act as central authorities that issue and control money in the economy.
  2. Unlimited supply: The fiat system does not require money to be backed by any physical commodity. Central banks can therefore inflate the money supply in the economy without any anchor to hold it back. The consequence? Devaluation of purchasing power in the form of inflation. 

 

Cryptocurrency (2009-)

Bitcoin is a decentralized digital currency that can be transferred on the peer-to-peer bitcoin network. Bitcoin transactions are verified by network nodes through cryptography and recorded in a public distributed ledger called a blockchain.

The reason for the italics? Because most people have little to no idea what that definition actually means. Similar to the first time we heard words such as electricity, the internet, and even cell phones, we are still very early in the adoption phase. What we do know, however, is that Bitcoin and other cryptocurrencies offer a solution to the problems of the fiat system. 

 

What are these solutions?

1) Decentralized: Before the internet, the flow of information was centralized and controlled by a few main players. The best (and often only) form of information was the daily newspaper. Today, information is decentralized, meaning that we can create and consume knowledge from around the world with a click of a button. Just like information was controlled in the previous era, money today is controlled by central banks. Bitcoin offers a viable, decentralized alternative.

2) Transparency: Bitcoin offers a transparent ledger via its blockchain. At any point in time, anyone can view the ledger with all its balances and transactions. The only thing we cannot see is who owns these balances and who is behind each transaction. Bitcoin is thus pseudo-anonymous, meaning that everything is open, transparent, and traceable, but the identity of participants remains unknown. 

3) Digital: Bitcoin was designed to be digital by nature (unlike fiat). This means you can add additional layers of programming on top of it and turn it into smart money. 

4) Monetary policy: One of the biggest criticisms of the fiat system is its mismanagement of the money supply. Bitcoins issuance is solely based on mathematics, which means that we know the exact amount of bitcoin that has been issued (or mined), and how much bitcoin will be mined per day, month, and year until the last block is mined in the year 2140.

5) International payments: International payments currently take place via the SWIFT payment system. This system is very slow and expensive to use. For example, if you want to buy US Dollars today, you will have to do it via a bank, it will take 1-2 business days for the money to arrive, and it will cost anywhere between R400 and R800 for the transaction. Bitcoin is borderless, meaning that we can send money to anyone, anywhere in the world at lightning speed and at a fraction of the cost.

 

A brief summary of our monetary systems:

  • Barter
  • Metal coins
  • Paper money
  • Gold standard
  • Bretton Woods
  • Fiat
  • Cryptocurrency

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