The Nature of Money

For most of us, the primary issue with money is that we do not think we have enough. However, the concept of money has a long history entwined with the development of economics, both as a theory and as a practical reality, which do not always align. However, while this discussion is not necessarily focused on the development of money in its physical form, as indicated below, it is interested in how the flow of money has changed, not only the way economies operate, but its wider effects on society that depends on the flow of money

In a historic context, early economies operated without money, usually based on some form of barter system. However, this system had many restrictions because it was difficult to equate the value of one item being exchanged against another or to compensate for any difference in value. In this respect, the idea of money was developed to better help facilitate the notion of a ‘transaction’, where money represents some nominal and agreed value, which allowed the exact amount agreed to be exchanged. Today, most of us understand the basic idea of money in the abstracted form of a fiat currency, i.e. banknotes and credit cards, which have no intrinsic value beyond being a promissory IOU backed by some accepted authority. However, earlier forms of money were often based on a physical coinage casted in a precious metal, e.g. gold, which had a perceived intrinsic value, although the legend of King Midas might question this wisdom.

Note: Based on this introduction, we might forward the idea that money is only an agreed proxy of some amount that facilitates the exchange of goods and services within a transaction.

If we accept the initial definition in the note above, where money has no intrinsic value, then we need to consider where value lies. As indicated, if money is only the proxy for the value being assigned to ‘goods or services’ , where the former may represent the value of material resources, while the latter may encompass some measure of, not only the time involved, but the skill required to deliver a service. At this point, we might attempt to introduce the basic idea of a coinage-based economy, as illustrated below.

In this simple model, we have an economy based on 4 trades [A..D], where each only trades with their adjacent neighbour by a balanced exchange of 50 coins for goods and services. From the directional flow of coinage, we might realise that a modern economist might described this situation as ‘stagnant’ zero-growth, while an ecologist might describe it as ‘sustainable’ on the assumption that the resources extracted by each trade, [RA..RD], is not excessive or polluting. However, let us proceed with this model on the assumption that each trader [A..D] has 100 coins, where they first buy 50 coins of goods from their adjacent neighbours, but then receive 50 coins from the neighbour for their own services. So, as indicated, this economy will neither grow or contract.

Note: At some point in history, it is believed that traders started to deposit their gold and silver coins with local goldsmiths, because they own the strongest safes. In return, the goldsmiths issued a paper receipt, which in-turn started to be used as a form of fiat currency and traded in preference to gold coins. However, it did not take long for this class of ‘goldsmith’ to notice that only about 10-20% of their receipts were ever redeemed at any given time. As a consequence, they started to ‘lend’ against, not only the gold reserves they held on behalf of others, but above this value, as they only required the 10-20% figure to meet the demand for gold to be redeemed. In modern economics, this idea is called leverage, while the goldsmith-banker would grow to become an essential part of the expanding economic model to be outlined in the next discussion.