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What is Money?

What do the following items have in common? Bronze knives, farm tools, cacao beans, salt chunks, stone disks, fish hooks, beaver pelts, musket balls, nails and cigarettes. Well the answer is that all of these items have been used as money! Money you say oh wise one? Yes, money. Not money in the sense that you know it today but yes, money.

Lets think about what money really is:

Money: Anything accepted as payment for goods and services by most people in an area at a given time.

Think about it, if most of the people in a region are willing to accept a certain item as payment for goods and services then that item has a use as money. It is sort of like the way cigarettes are portrayed as money in the movies. Now the reality is that these types of money, informal money that has another basic use if you will, are not money as you normally have thought of it. This type of money is called commodity money. The origins of money can be traced back to ancient times. Then commodity money, money that has an alternative use, was used. In the South Pacific and Africa, cowrie shells were the common forms of currency while in New Guinea, it was dog teeth that were used. At Santa Cruz, the feathers of hundreds of honey-eating birds were attached to short sticks to make feather-stick money while in the Marshall Islands, fishhooks were commonly used. In ancient China tea leaves were compressed into "bricks" while the Russians used compressed cheese as their currency. Commodity money was still present during the colonial age when many products such as gunpowder, musket balls, corn, and hemp were commonly used.

In 1618 tobacco became the most famous type of colonial money because the governor of colonial Virginia gave it a monetary value of three English shillings per pound. However, fiat money, money by government decree, has come to replace commodity money. In 1645 Connecticut established a monetary value for wampum, a form of currency that the Narragansett made out of white conch and black mussel shells. Because the Narragansett and the settlers used wampum in trade, certain shells were made equal to 1 English penny. In the 1700's the Governor of the then territory of Tennessee was paid a salary of 1000 deerskins a year! His secretary of state was paid 500 raccoon skins. Quite a salary huh!

As time progressed, other forms of money were used. In some states, laws were passed allowing citizens to print their own paper currency. Backed by gold and silver deposits in banks, it served as currency for the immediate area. Some states passed tax-anticipation notes that could be redeemed at the end of the year. The governments printed the notes, which were used to pay salaries, buy supplies, and meet other expenditures until taxes were received and the notes redeemed. The taxes though, were collected in coins.

Paper money was really first seen around the time of the Revolution. In 1775 the Continental Congress authorized the printing of Continental Currency which had no gold or silver backing. By the end of the war nearly $250 million had been printed and spent.

Money as you know it today is not commodity money. Today most money is what we call fiat money. Fiat money is money by government decree. Wampum was the first fiat money used in the America's. It had a set value, equal to a certain amount of gold, established by Connecticut in 1645. Since the government of Connecticut established it as official money it is fiat money.

The concept of paper currency was not well regarded early on. Most Americans, indeed most people world wide, felt that paper currency was risky since it had no inherent value. As a result most fiat money was in the form of coins. This coined money is known as specie. Specie was well regarded because it some metallic content, either gold or silver. Due to scarcity this then had some inherent value of its own. In fact paper currency was not even issued until 1775 when the Continental Congress printed a very small amount of paper currency to pay its debts.

So, why do we use money at all? Well the reality is that the use of money is very much tied to the Industrial Revolution. As the world grew increasingly modern money became needed. Before money was used the world was primarily agricultural. People living in traditional economies used barter as a means of exchanging goods and services. Barter presented great difficulty in completing transactions and in fixing value. With the Crusades and the corresponding growth of towns and villages and increased trade money became a necessity. Industrialization would have been impossible without money.

 

Money serves, therefore, three essential functions:

  • It is a Medium of Exchange - money is used so we can exchange goods and services easily. In barter this is very difficult because transfer of large items and perishable goods makes moving around a little tough.
  • It is a Measure of Value - money is used so we can assess fairly and consistently the comparative worth of items. In barter this could not occur because it is impossible to compare the value of different commodities consistently. For example, trading two cows for a goat and a three legged dog. Whose to say what is worth more??
  • It is a Store of Value - money is used so that we can save our earning for a later date In barter this cannot occur because often items might die or rot!

Money also has three essential characteristics.

  • Portability - Money is small and transportable. Imagine using certain types of commodity money. What if Cows where accepted as commodity money. Can you imagine walking around with a cow in your pocket??? A little difficult huh?
  • Divisibility - Money can be broken down into smaller or larger units of measure to make transactions easier. Can you imagine the cow scenario? Its not like you can rip of a leg if the whole cow wasn't necessary as payment!
  • Durability - Money lasts. Specie lasts forever and even paper currency is pretty durable. In class I ripped a twenty dollar bill in half once and then taped it back together. It was still worth the same wasn't it? Imagine trying that with a cow! Eventually even an un dismembered cow would die, rot and stink. Not too durable.
  • Stability of Value - Money, despite the influences of inflation and deflation remains fairly stable in value. Money is not subjected to the natural forces of weather as much early commodity was. In traditional economies when one needed goods he would trade crops. If there was a drought, however, the value of said crops would shoot way up. Since most money is in one way shape or form tied to known gold reserves, it is stable in value.


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