History of money

This article contains content from Wikipedia. Current versions of the GNU FDL article History of money on WP may contain information useful to the improvement of this article

WP

Social evolution

Money is an invention of the human mind. The creation of money is made possible because human beings have the capacity to accord value to symbols. Money is a symbol that represents the value of goods and services. The acceptance of any object as money – be it wampum, a gold coin, a paper currency note or a digital bank account balance – involves the consent of both the individual user and the community. Thus, all money has a psychological and a social as well as an economic dimension. As human society has evolved, the nature and function of money has evolved too. While a history of money may trace the origin and usage of different forms of money at different times and in different parts of the world, an evolutionary perspective on money traces the social and psychological changes in human attitude and collective behavior that made possible this historical development.

Barter

Before the invention of money, barter was the primary medium of exchange. An individual possessing a material object of value, such as a measure of grain, could directly exchange that object for another object perceived to have equivalent value, such as a small animal, a clay pot or a tool. The capacity to carry out transactions was severely limited since it depended on a coincidence of wants. The seller of food grain had to find a buyer who wanted to buy grain and who also could offer in return something the seller wanted to buy. There was no common medium of exchange into which both seller and buyer could convert their tradable commodities. There was no standard which could be applied to measure the relative value of various goods and services.

Commodity money

The first stage in the evolution of money was the acceptance of certain inherently valuable objects, such as metals, cows, goats or food grains, as a common standard of measure and unit of exchange. It was relatively easy for people to accept any of these as money because they had inherent use value for every individual and, therefore, their wide acceptance by other people was assured. All metals were accepted because they could be readily converted into precious tools and weapons, e.g. knives, axes, spears and spades. Gold and silver had secondary advantages. They were also easy to identify and visually attractive. Gold, silver, copper as well as other usable material objects such as salt and peppercorns are categorized as commodity money, since they combine the attributes both of a usable commodity and a symbol. People accepted foods and metals as money because they were sure of their value to themselves and to other people.

The introduction of metal coins marked a step or bridge in the evolution from usable commodities to symbolic forms of money. Although metal had a use value of its own, coins were accepted in trade for their symbolic value as a medium and standard measure for exchanging other goods and services of value rather than for utilization of the metal they contained.

The term commodity money is also applied to other objects of less obvious utility such as shells, beads and stones, whose utilitarian value was only decorative. This classification tends to blur an important distinction between money consisting of usable commodities and pure symbolic money.

Representative money

Representative money The next stage in the evolution of money involved a further transition from money as an object with inherent usefulness and value to money as a pure symbol of value. Representative money is symbolic money that is based on useful commodities. This category includes the warehouse receipts issued by the ancient Egyptian grain banks, the goldsmith receipts issued by England’s goldsmith bankers, bills of exchange based on tradable goods, and more recent forms of paper currency that were backed by and redeemable for gold or silver. The adoption of representative money represented a significant evolution in human consciousness. Psychologically, the individual had to transfer the sense of value from a usable material object to an abstract symbol. Socially, groups of people had to agree on the common usage of the same symbol.

Warehouse receipts

Warehouse receipts became a very successful form of representative money in ancient Egypt during the reign of the Ptolemies around 330 BC. Farmers deposited their surplus food grains for safe-keeping in royal or private warehouses and received in exchange written receipts for specific quantities of grain. The receipts were backed and redeemable for a usable commodity. Being much easier to carry, store and exchange than bags of grain, they were accepted in trade as a secure and more convenient form of payment, acting as a symbolic substitute for the quantities of food grain they represented. The warehouse receipt itself had no inherent value. It was only a symbol for something of value.

The invention of representative money had profound effect on the evolution of both money and society. It directly led to the creation of a new social organization, banking. The network of royal and private banks that were created during the reign of the Ptolemies constituted a national grain or giro-banking system. Grains were deposited in ‘banks’ for safekeeping. Warehouse receipts were accepted as a form of symbolic money because they were fully ‘backed’ by the grains in the warehouse.

More important but less obvious, the introduction of banking by the pharaohs made possible the creation of money. Until then new money could be grown as a crop, raised as an animal or discovered as metal in the earth. Now it could be created by writing a warehouse receipt. At first these receipts were issued only when additional grain was deposited and cancelled whenever the grain was withdrawn from the warehouse. But it required only a small step in imagination for the bankers to realize that they could also create new grain receipts on other occasions. If someone applied to the bank for financial assistance, the bank did not need to provide it in the form of grain. It could simply create and give to the borrower a new warehouse receipt that was indistinguishable from those issued when grain was deposited. Although the new receipts were not backed by additional deposits of grain, they were still backed by the total value of grain on deposit at the warehouse and, therefore, readily accepted in the market as a medium of exchange, so long as the public had trust and confidence in the overall financial strength of the grain bank.

This stage marks a crucial transition from money as a thing to money as a symbol of trust. In the case of commodity money, trust was placed in the inherent value of the metal or grain which constituted the form of payment. In the case of the warehouse receipt, trust was extended from the commodity to the social organization that held the grain and issued the receipts. This shift required a psychological willingness on the part of the individual to accept a symbol in place of a physical object and a social willingness on the part of the collective to evolve organizations and systems of account that could gain and hold the public trust.

These ancient girobanks went even further. They introduced standardized accounting methods and bank accounts for their depositors. Deposits could be recorded as numerical entries in their books of account. Large transfers of money from one account holder to another could be done without even exchanging warehouse receipts, simply by changing the account balances in the bank’s record books. The number in the record book became a symbolic form of representative money, an ancient forerunner of modern electronic forms of money.

Tallies

The acceptance of symbolic forms of money opened up vast new realms for human creativity. A symbol could be used to represent something of value that was available in physical storage somewhere else in space, such as grain in the warehouse. It could also be used to represent something of value that would be available later in time, such as a promissory note or bill of exchange, a document ordering someone to pay a certain sum of money to another on a specific date or when certain conditions have been fulfilled. In the 12th Century, the English monarchy introduced an early version of the bill of exchange in the form of a notched piece of wood known as a tally stick. Tallies originally came into use at a time when paper was rare and costly, but their use persisted until the early 19th Century, even after paper forms of money had become prevalent. The notches were used to denote various amounts of taxes payable to the crown. Initially tallies were simply used as a form of receipt to the tax payer at the time of rendering his dues. As the revenue department became more efficient, they began issuing tallies to denote a promise of the tax assessee to make future tax payments at specified times during the year. Each tally consisted of a matching pair – one stick was given to the assessee at the time of assessment representing the amount of taxes to be paid later and the other held by the Treasury representing the amount of taxes be collected at a future date. The Treasury discovered that these tallies could also be used to create money. When the crown had exhausted its current resources, it could use the tally receipts representing future tax payments due to the crown as a form of payment to its own creditors, who in turn could either collect the tax revenue directly from those assessed or use the same tally to pay their own taxes to the government. The tallies could also be sold to other parties in exchange for gold or silver coin at a discount reflecting the length of time remaining until the taxes was due for payment. Thus, the tallies became an accepted medium of exchange for some types of transactions and an accepted medium for store of value. Like the girobanks before it, the Treasury soon realized that it could also issue tallies that were not backed by any specific assessment of taxes. By doing so, the Treasury created new money that was backed by public trust and confidence in the monarchy rather than by specific revenue receipts.

Trade Bills of Exchange

Bills of exchange became prevalent with the expansion of European trade toward the end of the Middle Ages. A flourishing Italian wholesale trade in cloth, woolen clothing, wine, tin and other commodities was heavily dependent on credit for its rapid expansion. Goods were supplied to a buyer against a bill of exchange, which constituted the buyer’s promise to make payment at some specified future date. Provided that the buyer was reputable or the bill was endorsed by a credible guarantor, the seller could then present the bill to a merchant banker and redeem it in money at a discounted value before it actually became due. These bills could also be used as a form of payment by the seller to make additional purchases from his own suppliers. Thus, the bills – an early form of credit – became both a medium of exchange and a medium for storage of value. Like the loans made by the Egyptian grain banks, this trade credit became a significant source for the creation of new money. In England, bills of exchange became an important form of credit and money during last quarter of the 18th century and the first quarter of the 19th century before banknotes, checks and cash credit lines were widely available.

Goldsmith bankers

The highly successful ancient grain bank also served as a model for the emergence of the goldsmith bankers in 17th Century England. These were the early days of the mercantile revolution before the rise of the British Empire when merchant ships began plying the coastal seas laden with silks and spices from the orient and shrewd traders amassed huge hoards of gold in the bargain. Since no banks existed in England at the time, these entrepreneurs entrusted their wealth with the leading goldsmith of London, who already possessed stores of gold and private vaults within which to store it safely, and paid a fee for that service. In exchange for each deposit of precious metal, the goldsmiths issued paper receipts certifying the quantity and purity of the metal they held on deposit. Like the grain receipts, tallies and bills of exchange, the goldsmith receipts soon began to circulate as a safe and convenient form of money backed by gold and silver in the goldsmiths’ vaults.

Knowing that goldsmiths were laden with gold, it was only natural that other traders in need of capital might approach them for loans, which the goldsmiths made to trustworthy parties out of their gold hoards in exchange for interest. Like the grain bankers, goldsmith began issuing loans by creating additional paper gold receipts that were generally accepted in trade and were indistinguishable from the receipts issued to parties that deposited gold. Both represented a promise to redeem the receipt in exchange for a certain amount of metal. Since no one other than the goldsmith knew how much gold he held in store and how much was the value of his receipts held by the public, he was able to issue receipts for greater value than the gold he held. Gold deposits were relatively stable, often remaining with the goldsmith for years on end, so there was little risk of default so long as public trust in the goldsmith’s integrity and financial soundness was maintained. Thus, the goldsmiths of London became the forerunners of British banking and prominent creators of new money. They created money based on public trust.

Banknotes

The history of money and banking are inseparably interlinked. The multiplication of money really took off when banks got into the business. Inspired by the success of the London goldsmiths, some of which became the forerunners of great English banks, banks began issuing paper notes quite properly termed ‘banknotes’ which circulated in the same way that government issued currency circulates today. In England this practice continued up to 1694. Scottish banks continued issuing notes until 1850. In USA, this practice continued through the 19th Century, where at one time there were more than 5000 different types of bank notes issued by various commercial banks in America. Only the notes issued by the largest, most creditworthy banks were widely accepted. The script of smaller, lesser known institutions circulated locally. Farther from home it was only accepted at a discounted rate, if it was accepted at all. The proliferation of types of money went hand in hand with a multiplication in the number of financial institutions.

These banknotes were a form of representative money which could be converted into gold or silver by application at the bank. Since banks issued notes far in excess of the gold and silver they kept on deposit, sudden loss of public confidence in a bank could precipitate mass redemption of banknotes and result in ‘’bankruptcy’’.

The use of bank notes issued by private commercial banks as legal tender has gradually been replaced by the issuance of bank notes authorized and controlled by national governments. The Bank of England was granted sole rights for the issuance of banknotes in England after 1694. In the USA, the Federal Reserve Bank was granted similar rights after its establishment in 1913. Until recently, these government-authorized currencies were forms of representative money, since they were partially backed by gold or silver and convertible into metal under certain circumstances.

Demand deposits

The primary business of the grain and goldsmith bankers was safe storage of savings. The primary business of the early merchant banks was promotion of trade. The new class of commercial banks made accepting deposits and issuing loans their principal activity. They lend the money they received on deposit. They created additional money in the form of new bank notes. They also created additional money in the form of demand deposits simply by making numerical entries in the ledgers of their account holders. The money they created was partially backed by gold, silver or other assets and partially backed only by public trust in the institutions that created it.

Gold-backed banknotes

For most of us, the term gold standard is erroneously thought to refer to a time when currency notes were fully backed by and redeemable in an equivalent amount of gold. The British pound was the strongest, most stable currency of the 19th Century and often considered the closest equivalent to pure gold, yet at the height of the gold standard there was only sufficient gold in the British treasury to redeem a small fraction of the currency then in circulation. In 1880, US government gold stock was equivalent in value to only 16% of currency and demand deposits in commercial banks. By 1970, it was about 0.5%. The gold standard was only a system for exchange of value between national currencies, never an agreement to redeem all paper notes for gold. The classic gold standard prevailed during the period 1880 and 1913 when a core of leading trading nations agreed to adhere to a fixed gold price and continuous convertibility for their currencies. Gold was used to settle accounts between these nations. With the outbreak of World War I, Britain was forced to abandon the gold standard even for their international transactions. Other nations quickly followed suit. After a brief attempt to revive the gold standard during the 1920s, it was finally abandoned by Britain and other leading nations during the Great Depression. Prior to the abolition of the gold standard, the following words were printed on the face of every US dollar: “I promise to pay the bearer on demand, the sum of one dollar” followed by the signature of the US Secretary of the Treasury. Other denominations carried similar pledges proportionate to the face value of each note. The currencies of other nations bore similar promises too. In earlier times this promise signified that a bearer could redeem currency notes for their equivalent value in gold or silver. The US adopted a silver standard in 1785, meaning that the value of the US dollar represented a certain equivalent weight in silver and could be redeemed in silver coins. But even at its inception, the US Government was not required to maintain silver reserves sufficient to redeem all the notes that it issued. Through much of the 20th Century until 1971, the US dollar was ‘backed’ by gold, but from 1934 only foreign holders of the notes could exchange them for metal..

Fiat money

Since 1971 the US dollar is not backed by anything. It is pure fiat money. The promise to exchange it for gold or silver was quietly withdrawn, and currency notes no longer carry that pledge. The same is true of all major currencies in the world today.

This marks the final stage in the evolution of pure fiat money which is neither backed by a commodity nor convertible into a commodity. Fiat money has become the standard form of national currency since abandonment of the gold standard. Banknotes issued by private banks were backed by the total deposits of the banks that issued them, however inadequate those deposits might be to reimburse all depositors. Notes issued by the US Federal Reserve or other central banks are backed only by the perception of public confidence in the stability of government and the productive capacity of the country that issues them. The transition from bank notes to government-guaranteed currency marks the evolution from trust in a financial institution to trust in the economic capacity and future prosperity of the nation. The greater a country’s production and productivity, the more the goods and services it offers in exchange for legal tender, and therefore the greater the confidence and trust in that currency. That is a major reason why the value of the euro has risen as the European Union had expanded to include more countries with greater productive capacity.

Credit money

Credit money often exists in conjunction with other money such as fiat money or commodity money, and from the user's point of view is indistinguishable from it. Most of the western world's money is credit money derived from national fiat money currencies.

In a modern economy, a bank will lend to borrowers in excess of the reserve it carries at any time, this is known as fractional reserve banking. In doing so, it increases the total money supply above that of the total amount of the fiat money in existence (also known as M0). While a bank will not have access to sufficient cash (fiat money) to meet all the obligations it has to depositors if they wish to withdraw the balance of their cheque accounts (credit money), the majority of transactions will occur using the credit money (cheques and electronic transfers).

Strictly speaking a debt is not money, primarily because debt can not act as a unit of account. All debts are denominated in units of something external to the debt. However, credit money certainly acts as a substitute for money when it is used in other functions of money (medium of exchange and store of value).