The Value of Money

Posted on Aug 07,2017

Money is funny, no? I mean, I’m sure we all have those doubts sometimes. ‘Why does this piece of paper have value? Why can I use it to buy things?’ After all, we look at how it’s built and suspect there isn’t actually anything underneath it that holds any kind of value.

That makes a lot of people nervous. They argue that something that is built on air must fall down eventually. They want to return to a system like we had previously, where every dollar, pound or ringgit can be exchanged for a certain amount of precious metal.

The thing is, is money actually built on air? Is there really nothing underneath it? And are precious metal actually a better solution?

To answer those questions, let’s take a trip through monetary history.

The history of money

We didn’t start off with money. Originally, we had a barter system. This basically amounts to, ‘I have two fish I can’t eat. Will you give me that extra basket of flour you have for it?’ In these situations, the value of what is being traded is decided by both parties.

I think my two fish are worth a basket of flour. Do you agree?

Of course, there is one problem with barter and that is, what if you don’t like fish? Then you won’t agree that it’s worth that much. This leaves me with two fish I don’t need and you with an extra basket of flour. Of course, we could then find somebody else to trade with, but that’s extra work. It would be much easier if we could abstract out the notion of value from the fish and flour and use that as a basis for exchange.

And that’s what happened. Either by accident or design, people started accepting other things as intermediaries to the products they had and wanted. A lot of different things were used. For example, the Chinese used seashells. In Micronesia, they used massive stone disks that people couldn’t even pick up. More common, however, was the use of valuable minerals. These could more easily be shaped and marked and were sufficiently rare that somebody could go out and just get lots more.

Coins and paper money

To standardize precious metals we started using coins. They didn’t work like modern-day coins, however. It wasn’t the seal that gave the coin value. Instead, the seal only told people that the bank or royal family guaranteed the coin held a certain amount of precious metal.

I hereby decree that all these coins with my image on them have this much gold in them.

This was useful, as many people did not have properly weighed scales at that time nor was there some central agency that decided how much a pound actually weighed. And so, my pound could be entirely different from your pound. Much better if instead, we have somebody who we trust decide that for us.

The next level of abstraction – paper money – originally started out as IOUs. Basically, medieval banks would write pieces of paper that you could then take to another branch in another part of the world and there exchange it for coins. Initially, these IOUs could only be cashed in by one person. Then, somebody had the bright idea to let anybody do so.

That made it possible to exchange these papers just like people in the past had used coins. And if people trusted the house that held the coins, then why actually collect the coins? A piece of paper is a lot lighter, after all!

You can still see the mark of that on one modern-day currency. The English Pound is called a ‘pound’ because originally it was actually an IOU for a pound of silver.

Then, during the beginning of the 20th century and the resulting upheaval, many countries decoupled their money from rare minerals and undid what was called ‘the gold standard’. It didn’t happen all at once. It took several decades of back and forth with countries temporarily suspending it, going off it, coming back onto it and so on.

But eventually, during the great depression, the final blow was struck. It was no longer possible to exchange money for a certain amount of a valuable mineral. And that’s where we are today.

Natural progression

As you can see, money has taken a lot of different forms over the years. Initially, value was only held in the object that we wanted. Then we started using a physical intermediary, like seashells and gold. From there, it progressed to an object, like paper bills, which represented that intermediary. And finally the intermediary was taken away and we were left with the concept of money we have today.

The thing to notice is where the value resides. It doesn’t reside in the bills or in the precious metal. No chemical analysis will separate out something called ‘value’ that you can measure and weigh. It doesn’t even reside in the fish. After all, if you don’t want my fish, then for you it holds no value.

Instead, the value of money is something cultural. Money has value because we all agree that it does. It doesn’t matter what form it takes. It can be gold, paper or seashells. Really they’re just collectively agreed tokens for measuring value.

This idea scares the sheep out of a lot of people. They think that if it’s a cultural agreement, then it can’t possibly be stable. What if we all wake up tomorrow and decide not to accept money anymore?

It’s an understandable reaction. Culture does seem to be something abstract and ephemeral. Of course, it isn’t. There are many incredibly stable cultural phenomenon. Nationality and language, for example.

If I ask, ‘what if we all wake up tomorrow and decide to not accept the English language anymore?’ or if suggest, ‘Let’s decide to stop being Americans’, you will think I’m being absurd.

And so it goes for money. It really doesn’t matter what form it takes – something admirably demonstrated by how many forms it has already taken.

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