Money Is a . . . Store of Value
Economists also define money as a store of value. By this, they mean that money must be able to be stored away and used later. For example, if the U.S. dollar was perishable, or had an expiration date, then it could not serve as an effective store of value. This can be applied to our earlier example of bananas. Within a week or less, a banana can rot. Bananas would not make a very stable form of money as they would lose their value very quickly. Money should be nonperishable and must hold its value for future needs and wants over time.
Money is a . . . Unit of Account
Finally, money must be a unit of account. What does that mean? It means that the prices within an economy should be expressed in a universally accepted monetary unit. For example, without a single universally accepted form of money, how could storeowners price their items? The prices of goods and services would be very difficult to determine without a unit of account. What if you wanted to pay for your goods with your bananas and another customer wanted to pay with pineapples? How could the store owner possibly know how to price his goods under such a complex system? Today’s economic environment has become far too complex and interdependent to rely upon such an antiquated system of barter. People no longer have to produce everything they consume. Instead, they can simply trade money for the goods or services that they do not, or cannot, produce. Our modern economy requires a cohesive and universal monetary system that can serve as a unit of account.
The Brief Evolution of Money
The history and evolution of money is a story that spans thousands of years. And while money and trade have become more sophisticated over time, we have evidence that several early civilizations had forms of advanced monetary systems. One of the first civilizations to develop a system of trade with a form of money was ancient Sumer. The Sumerians were highly advanced in many areas, including their system of economy and trade.
From the days of ancient Sumer to our present day, money and trade have taken many different forms. The most primitive type, and earliest form, of money is commodity money. Commodity money is a unique form of money that serves a dual purpose. It can be used for trade or it can be consumed by the owner. Early civilizations, for example, used common items as commodity money, including spearheads, shells, feathers, and salt. In ancient times, for example, salt could be used for trading purposes. But the owner always had the option of consuming the salt himself. Salt could also be used for antiseptic purposes and for preserving food, among other uses. This is unlike our current paper money system that serves only one purpose, that is, trade. Paper money has no other use if it is not backed by a commodity. Because commodity money has a dual purpose, it is said to have an intrinsic value.
Over time, the portability and durability of money became important to merchants and traders as societies became more interconnected. As the old saying goes, “Necessity is the mother of invention.” This need for more versatility in financial transactions led to the rise of gold and silver as money. Unlike crops, gold and silver were scarce, durable, and non-perishable. In addition, gold and silver were far superior to livestock in that they 1) were much easier to transport, 2) required little maintenance costs, and 3) had the unique capability of being divided for exact payment. Soon, gold and silver were made into the form of coins with their values stamped on them. This simple but revolutionary act made financial transactions more convenient and represented man’s first real attempts at coined currency.
It did not take long, however, for those in search of dishonest gain to exploit the gold and silver monetary system. How? Those who wanted to cheat the system did so by placing gold or silver plating over cheaper metal discs to imitate the appearance of solid gold and silver coins. Local governments would often step into the “money-making business” to prevent such counterfeiting efforts. Despite these efforts, counterfeiting remained a constant challenge to most forms of money. This is true even to this day.
The superior aspects of gold and silver meant that they soon became the money of choice for many people. But as people began to accumulate large sums of gold or silver coins in their homes, concerns over keeping them safe from theft or loss became a major concern. This demand for safety led to the creation of one of the earliest forms of modern banking, known as goldsmith banking.
Under the goldsmith banking system, which became popular in 17th-century England, a person would simply deposit his gold with his local goldsmith. Much like modern banking, the goldsmith would provide the depositor with a paper receipt stating the amount of gold on deposit. If the person wanted to redeem his gold, he simply returned his paper receipt to the goldsmith. (In exchange for this convenience of keeping the gold in a safe place, the town’s goldsmith would charge a small monthly maintenance fee.) Because these paper receipts were viewed as “good as gold” they became extremely valuable. As communities grew and trade activity increased, these paper receipts began to be accepted as payment for simple financial transactions.
Eventually, traders and merchants in need of capital began seeking out loans from the goldsmiths. Most goldsmiths embraced the new income opportunity and were willing lenders. Despite the novelty of this financial system, the lending process was fairly simple. The goldsmith created and issued a paper receipt to the borrower which gave the appearance that the borrower had gold in the goldsmith’s vaults. But in reality, no new gold reserves were backing this loaned paper receipt. The goldsmith knew that the only way this scheme would be discovered was if many of his depositors were to demand all of their gold at the same time. Because the goldsmith considered this highly unlikely, he could continue to profit from his newfound lending power with little fear of a default risk. (This idea of lending money not currently on deposit has become a highly profitable venture for bankers. It is known as fractional-reserve banking and is discussed at length in chapter 7, “Modern Money Mechanics: What the Banksters Do Not Want You to Know.”)
As the Industrial Revolution began, the demand for loans grew dramatically. The large profit potential through this new sleight-of-hand lending process led to a rise in competition. Small regional banks began issuing their own forms of paper currency, similar to the paper receipts created by goldsmiths, in order to compete. As nations grew in population and in commercial activity, the various forms of issued currency became overwhelming, often stifling the flow of commerce. When nations faced such pressures, the largest banks would seek a monopoly on national lending by recommending a unified paper currency system to the governing authorities. These new paper currency systems were often backed by some form of commodity, usually gold or silver. Of course, implementing and regulating a national paper currency system was a monumental task requiring vigilant oversight. Western governments, in particular, often capitulated to the banking interests by permitting the creation of one national central bank. The central bank’s role often included issuing the national currency of choice (almost exclusively paper money), regulating the money supply, and controlling interest rates. In addition, the central bank would often be responsible for monitoring the nation’s banking activity, and serving as the lender of last resort, due to its unique capability of creating the national currency.
Despite the sophistication of the new central banking arrangement, discrepancies between the government’s fiscal policies and the central bank’s monetary policies often led to economic upheaval. The result of these conflicting policies, coupled with the unpredictable economic