Modern money for modern markets – Part IV

by | Aug 10, 2018

Did money emerge to solve barter?

We’ve covered all the gains that can be accumulated with a reliable store of value, and our previous article discussed all the convenience achieved through a common unit of account. Now we dive into what is – for some academics at least – not only the most important characteristic of money and of currency, but also the principal reason behind its origin… being a widely accepted means of exchange.

These academics believe in the traditional theory of barter, which cites exchange as the original source for the development of money.  We’ve already rebutted it twice – on Part II, by providing a more persuasive account of why the need for transferring wealth likely preceded the need for trading; and on Part III, by showing how an authority must declare an abstract value for money to circulate. Still, as this theory is widely studied, let’s dive in to explore its interesting lessons.

In brief, those who advocate the organic emergence of money in response to the needs of exchange continue to extoll anything informally used to settle a trade as a proper form of money. And that’s quite relevant to learn how currencies once considered informal can suddenly become widely accepted – even by authorities – and vice versa.

 

Money as common ground

As per usual, when thinking about money it’s very important to consider all three major use cases – store of value, unit of account, and medium of exchange – even when dissecting one in particular. In the matter of the evolution of money as a medium of exchange, it’s easier to understand why people chose some commodities to trade as opposed to others if we consider money as something with intrinsic value for all.

Let’s look at an example of the barter model to further clarify. Without money, and not considering favors or payment in kind, people traded what they had for what they wanted. If one wanted bread but only had meat then they had to find someone with bread who also wanted meat – a complicated endeavor that slowed down the economic flow.

This problem is widely known as the coincidence of wants. And some claim money originated from the valuable commodities that neatly eliminated this issue. Simply put, those who wanted to trade needed something considered mutually beneficial to facilitate the exchange.

At the beginning of such a system, those items actually were not precious metals because at the time precious metals lacked intrinsic value – at least until modern industrial applications. Most commonly, useful commodities such as salt, cattle, tobacco, silk, or cereals were chosen as money to facilitate trade, in large part because they could easily be recognized as valuable for both parties. Note that while these are considered valuable and limited, their scarcity is not of the kind associated with gold, silver, or even shells and cowries – all of which later became forms of money as we see it today.

 

Money as an option to spend

So, as we’ve covered, the earliest forms of money were effectively “anything momentarily useful” that had a value recognized by both parties. However, as societies became more specialized and with a finer division of labour, it made less and less sense to trust in informal, useful currencies as money, because these useful commodities were better put to use as food, as a method of conservation, or as raw material for production of clothing and other worldly goods. So, money as a means of exchange then was forced to evolve into money as an option to spend.

In this process, traders transitioned to more formal, symbolic forms of money to further reduce transaction costs. While cattle might be able to store value – and due to their lack of liquidity be a great tool to nudge farmers into increasing their savings – cattle as a form of money was expensive to maintain and also quite an inconvenient medium of exchange for daily transactions.

It is at this point, when the thought of money increasingly grows more abstract, that the first (partially) fiduciary currencies appear, i.e. those based on trust. This opened the way for governments to decree what is or isn’t accepted as money for the purpose of tax payments, which further defined what was and wasn’t money as a medium of exchange. And, as a result, effectively created the first fiat currencies, i.e. those based on authoritative order.

 

Money as a way to decentralize exchanges

As economies became increasingly complex to govern, authorities kept centralizing societal functions on the basis of improvements in efficiency. This process became critical to the role of medium of exchange that money played, as rulers began to ordain what was and wasn’t considered money, promoting the standardization of currency across jurisdictions.

While such monetary harmonization facilitated the exchange of goods and services, an apparent downside emerged. In the beginning, governments managed to transition to fiat currency through a combination of authority and credibility. But soon the ability to exercise control over people became more tempting, and individual citizens and small communities lost control over what was widely accepted as a means of exchange. Trade became subject to complex regulations and its profits subject to seizure and coercion from the ruler, which did not always have the best interests of their population in mind.

The historical examples of such appropriation fuel the desire to conduct free exchange outside of the control of over-regulating, overstepping authorities. This is why precious metals have continued to thrive as a form of money across time and societies, due to their dense store of value and ability to live mostly outside of the traditional banking system, something especially valuable during periods of financial instability. However, while a thriving precious metals market exists and transacts more than $20B daily, as a means of exchange bullion and coins are cumbersome to use, more so in the digital age, when everyone prefers convenient solutions.

In the recent years, the ongoing desire to innovate beyond overzealous institutions who keep trying to centralize whatever menaces their control is one of the many factors that has fueled the growth of cryptocurrencies. Part of the appeal of decentralization is this very factor – to facilitate direct transactions between people, reducing friction and interferences in the process, at nearly instantaneous speeds across continents. While adoption is still nascent, and even though cryptoasset markets continue to be volatile, innovation shows no sign of slowing down and becoming a universal means of exchange is the end goal of many projects.

 

The final step

Even though cryptocurrencies are not yet widely used as a medium of exchange, this is aligned with how money came to be. First, things became stores of value as people considered their natural properties as a symbol of wealth. Only after were they used for payments due to their newly-found utility – whenever there wasn’t already intrinsic value.

In the last post of our Modern Money series, we’ll tie up this comprehensive context of money’s traditional use cases with today’s cryptocurrency’s technological panorama, and conclude with an optimistic outlook of how can cryptoassets – powered by decentralised digital currencies – improve the financial dimension of our lives.