All the history of money — in 5 minutes
Yuval Noah Harari has called money the greatest fiction ever created by humans. Tyler Winklevoss (Facebook fame) calls money the largest social network ever. Whatever money is, it sure does play an extremely important role in our lives. The book “What Has Government Done To Our Money” has some mind-bending ideas on how did money came to be and its journey since. I read but a summary of this book and here, I try to further summarize it for you.
Pre-money
Before money, exchanges were made through a barter system. The challenges are well known — finding a trader to participate in an exchange and agreeing with him on a fair exchange rate.
Commodity as money
Enter the first version of money. Easily transportable and distributable, widely accepted commodities — butter, salt, tobacco, wheat. Gradually, metals emerge victorious because of their durability. Silver and gold function as money for a long time. Gradually, after widespread adoption of precious metals as money, people begin to understand the concept of exchange rates in terms of gold or silver — the first version of product cost price.
Metal coins
As kings become aware, they confiscate all money circulating in their jurisdiction. They start “regulating” the money flow by stamping and issuing little discs of metal with uniform weight — the first coins.
Problem with metal coins
Since the value of the coin is determined by the royal stamp and is not disputable, kings can reduce the uniform weight over time, allowing them to create more coins out of the same metal. This is known as coin debasement and allows kings to invent new money, causing the first inflation in history. As coins get lighter, some people might get skeptical. Also, lighter coins are not durable enough and will need to be replaced anyway. This causes kings and governments to invent paper money. Not to mention, the people are told that paper money is needed since metal is hard to carry.
Paper money and Banks
Banks started as warehouses of metal money. If you had gold or gold money, you would deposit that in a bank and they will issue you a receipt — a bank note. You could use this bank note anywhere it is deemed legal and get services or products equivalent to the corresponding value of gold. And here is the prize — the price of your gold will keep increasing while it is with the bank. This is the interest you earn.
But, the banks want to become rich too, and they realize that not everyone will come asking for their gold at once. So, they started giving out loans. Even if you don’t have gold to deposit, you can get bank notes issued if you agree (on paper) that you’ll pay it back with interest. Now, the bank has much less value of gold in its vault than the value of money floating in the market. This is known as functioning on fractional reserve.
Central Banks and Government
There are many different banks with their own designer bank notes. What happens if a bank decides to increase the interest rate on deposited gold? Everyone will want to take their gold out from other banks and deposit in this bank. But, the other bank are not equipped to return all the gold at once — they don’t have that much gold. The bank will default and people will lose all their money.
Enter central banks. These banks hold all the gold that was distributed between banks. Only the central bank can publish notes which will be used by all banks and everyone else in the country. The business of lending money and growing money is still with the consumer banks but they have nothing more than database entries to run that business.
If these consumer banks were to malfunction, the central bank can bail the bank out with its huge gold reserves. As you would have guessed, central banks also run on fractional reserve.
The most noteworthy point here is that central banks are government-controlled. This gives government unprecedented power over all this money — they can borrow as much as they want, and print money to hide their failures. The government can control inflation and deflation through the knobs that the control over central banks give them.
Fiat money
All this is still good since the gold standard at some level ensures that things do not go out of hand. International trade still happens in gold because the US would not recognize the Indian rupee.
However, at some point, the central banks of the world collude and give up the gold standard altogether and invent this thing called fiat money — a money not backed by gold or anything else but valued because the government said so. Since there is no baseline, the guideline is to print as less money as possible but enough to sustain the country’s expenses. As you would imagine, governments dangerously violate this guideline. That is why there comes a time when a 100-trillion Zimbabwean dollar is worth about 40 cents in US currency.
For international trade to function with fiat money, countries should now recognize and value each other’s currencies. That is how the concept of international exchange rate starts. This leads to interesting phenomena — for example, China has artificially lowered Yuan’s value as against the US dollar. This makes Chinese exports cheaper all around the world and help establish China as the largest exporter in world market.
New forms of money
What we are seeing now is the emergence of an unregulated universal currency. Because of its underlying mechanism is based on cryptography, this is called cryptocurrency. Just like the first version of money, the idea was proposed by individuals (in the crypto case, the mysterious Satoshi Nakamoto) and is now accepted by many of us in the global village. Governments around the world are trying to either ban it or gain control over it as it happened to gold in the past. The question is — Will the people of the world let it happen again?
I wanted to make this post as small as possible and that is why, quite a lot of events and repercussions are missing from the discussion. If you think there is an important aspect that should be added, call it out in the comments and I will try to include it.
