1 BASICS AND ORIGINS OF MONEY

1.0 Learning objectives

After reading this chapter, you should be able to:
 Know why we study money;
 Know the history of money;
 Explain the various dimensions of the evolution of the barter system;
 Describe inconveniences of the barter system.

1.1 Introduction
Money, as we know it today, is the result of a long process. In the beginning,
there was no money. People engaged in barter, the exchange of merchandise
for merchandise, without value equivalence.

1.2 Why Study Money?

• To explore the history of money;

• To get more knowledge about the functions, characteristics, and types
of money;
• To explore monetary standards and monetary value;
• To examine the role of money in the economy;
• To know more about monetary policies.

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1.3 The History of Money

There are numerous myths about the origins of money. The concept of
money is often confused with coinage. Coins are a relatively modern form
of money. Their first appearance was probably among the Lydians, in Asia
Minor in the 7th century BC. And whether these coins were used as money
in the modern sense has also been questioned.

To determine the earliest use of money, we need to define what we mean by

money. We will return to this issue shortly. However, with any reasonable
definition, the first use of money is as old as human civilization. The early
Persians deposited their grain in the state or church granaries. The receipts
of deposit were then used as methods of payment in the economies. Thus,
banks were invented before coins. Ancient Egypt had a similar system, but
instead of receipts, they used orders of withdrawal - thus making their
system very close to that of modern checks. In fact, during Alexander the
great’s period, the granaries were linked together, making checks in the 3rd
century BC more convenient than British checks in the 1980s. The
Egyptians had in fact invented the first giro system.

However, money is older than written history. Recent anthropological and

linguistic research indicates that not only is money very old, but its origin
has little to do with trading, thus contradicting another common myth.
Rather, money was first used in a social setting. Probably at first as a method
of punishment. Dowries were probably also an early use. These early origins
have left their traces in our language - as in “pay one’s dues”.

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Early Stone Age man began the use of precious metals as money. Until the
invention of coins, metals were weighed to determine their value. Counting
is of course more practical, the first standardized ingots appeared around
2200 BC. Other commonplace objects were subsequently used in the
abstract sense, for example, miniature axes, nails, swords, etc.

Full standardization arrived with coins, approximately 700 BC. The first
printed money appeared in China, around 800 AD. The first severe inflation
was in the 11th century AD. The Mongols adopted the banknote system in
the 13th century, which Marco Polo wrote about. The Mongol banknotes
were “legal tender”, i.e. it was a capital offence to refuse them as payment.
By the late 1400s, centuries of inflation found eliminated printed banknotes
in China. They were reinvented in Europe in the wake 17th century.

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Table 1. Some early stages of developing money

The first people did not buy goods from other people with
money. They used to barter. Barter is the exchange of personal
possessions of value for other goods that you want. This kind
of exchange started at the beginning of humankind and is still
Barter
used today. From 9,000-6,000 B.C., livestock was often used
as a unit of exchange. Later, as agriculture developed, people
used crops for barter. For example, I could ask another farmer
to trade a pound of apples for a pound of bananas.

At about 1200 B.C. in China, cowry shells became the first

Shells medium of exchange or money. The cowry has served as
money throughout history even to the middle of this century.

China, in 1,000 B.C., produced mock cowry shells at the end

of the Stone Age. They can be thought of as the original
development of the metal currency. In addition, tools made of
First Metal metal, like knives and spades, were also used in China as
Money money. From these models, we developed today's round coins
that we use daily. The Chinese coins were usually made out of
base metals that had holes in them so that you could put the
coins together to make a chain.

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Early stages of developing money (continued)

At about 500 B.C., pieces of silver were the earliest

coins. Eventually, in time, they took the appearance of today
and were imprinted with numerous gods and emperors to mark
their value. These coins were first shown in Lydia, or Turkey,
during this time, but the methods were used repeatedly, and
Silver
further improved upon by the Greek, Persian, Macedonian,
and Roman empires. Not like Chinese coins, which relied on
base metals, these new coins were composed of scarce metals
such as bronze, gold, and silver, which had a lot of intrinsic
value.

In 118 B.C., banknotes in the form of leather money were used

in China. One-foot square pieces of white deerskin edged in
Leather
vivid colours were exchanged for goods. This is believed to be
the beginning of a kind of paper money.

From the ninth century to the fifteenth century A.D., in China,

the first actual paper currency was used as money. Through
this period, the amount of currency skyrocketed causing
Paper
severe inflation. Unfortunately, in 1455 the use of the currency
vanished from China. European civilization still would not
have paper currency for many years.

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Early stages of developing money (continued)

In 1816, England made gold a benchmark of value. This meant

that the value of a currency was pegged to a certain number of
ounces of gold. This would help to prevent inflation of the
currency. The U.S. went on the gold standard in 1900. Because
Gold of the depression of the 1930s, the U.S. began a worldwide
movement to end tying the currency to gold. Today, few
nations tie the value of their currency to the price of gold.
Other government and financial institutions now try to control
inflation.

At present, nations continue to change their currencies. For

Today example, the U.S. has already changed its $100 and $20
banknotes.

Tomorrow is already here. Electronic money (or digital cash)

Tomorrow
is already being exchanged over the Internet.

1.4 The Barter System

Barter is a system of exchange by which goods or services are directly
exchanged for other goods or services without using a medium of exchange,
such as money. It is usually bilateral, but may be multilateral, and usually
exists parallel to monetary systems in most developed countries, though to
a very limited extent. Barter usually replaces money as the method of
exchange in times of monetary crisis, such as when the currency may be
either unstable (e.g., hyperinflation or deflationary spiral) or simply
unavailable for conducting commerce).

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The barter system is an age-old method that was adopted by people to
exchange their services and goods. This system was used for centuries,
before the invention of money. People used to exchange goods or services
for other goods or services in return. Nowadays, barter services have staged
a comeback with the advent of more sophisticated techniques that aid
trading through the Internet. During ancient times, the barter system was a
local phenomenon, which involved people in the same locality. However,
today the barter system has become global. You can now negotiate with the
opposite party, regarding the value of the item you want to barter and vice
versa. The advantage of bartering is that it does not involve money. You can
buy an item in exchange for some other thing you currently have but do not
want. This type of trading can be done through swap markets and online
auctions.

Figure 1. Example of the barter system

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Before the evolution of money exchange was done based on the direct
exchange of goods and service this is known as barter as distinct of money.
In a barter economy, goods buy goods, while in a monetary economy goods
buy money and money buy goods. Bartering was common in primitive
societies and it is still practised at places where the use of money has not
spread much in few underdevelopment economies.

1.5 Inconveniences of Barter System

1. Lack of double coincidence of wants

A barter exchange is possible when there is a double coincidence of

wants. When goods have to be directly exchanged for goods, it is
essential that both the parties should be ready to exchange each other
possessions. For instance, if X possessed rice, and wanted to exchange
it for wheat, hence he had to find a person who not only possessed wheat
but also is ready to exchange it for rice. It was difficult to find such
persons who required what you wanted to sell and he has what you want
to buy. Thus, it was time-consuming and inconvenient.

Example: A man having one commodity to trade should be able to find

another person not only wanted the same commodity but also had
something acceptable to offer in exchange.

2. Lack of common measures of value

Under this system, the value of goods was measured in relative terms.
It lacked any common measure of the value of the unit of account. There

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was no common measuring rod in terms of which values of all
commodities could be expressed conveniently. For example, when
wheat was exchanged for potato, the person should decide in what
proportion the wheat and the potato should be exchanged. The ratio was
arbitrary depending upon the relative need and urgency of two parties.
In this, the person badly in need of exchange suffered and did not get
the full value of the commodity he possessed.

3. Lack of subdivision of commodities

Sometimes it was very difficult to subdivide the commodity and then

exchange. Not all goods could be divided into a fraction. For example,
if a person wants to sell a hen for some quantity of wheat, it was difficult
to sell a part of a hen for wheat. Smooth exchange of goods was
impossible for wants of means of sub-dividing goods according to
people's requirements.

4. Lack of store value

In a barter system, it was difficult to store and accumulate wealth. Only

non-perishable goods like cows, sheep etc. could be stored. It was very
difficult to store both types of goods for a long period. Therefore, the
value of the product was also lost.

5. Lack of standard of deferred payments

Credit transactions were not easily carried out in the barter system.
Therefore, it was difficult to undertake any contract that involves future
payment.

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6. Lack of specialization
Under this system, specialization is limited, due to the limited exchange
system and market.

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1.6 Suggested Browsing

https://www.mint.com/barter-system-history-the-past-and-present

https://en.wikipedia.org/wiki/Barter

https://study.com/academy/answer/what-is-a-barter-system.html

https://www.quora.com/What-is-the-barter-system

http://library.thinkquest.org/28718/history.html?tql-iframe#top of page

1.7 Suggested Reading

Ball, R. J. Inflation and the Theory of Money. Piscataway, NJ: Aldine

Transaction, 2007.

Barth, James, S. Trimbath, and Glenn Yago. The Savings and Loan Crisis:
Lessons from a Regulatory Failure. New York: Springer, 2004.

Bernanke, Ben S. Essays on the Great Depression. Princeton, NJ:

Princeton University Press, 2000.

Bernstein, Peter. A Primer on Money, Banking, and Gold. Hoboken, NJ:

John Wiley and Sons, 2008.

Bremner, Robert. Chairman of the Fed: William McChesney Martin Jr.

and the Creation of the American Financial System. New Haven, CT: Yale
University Press, 2004.

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Davies, Glyn. A History of Money: From Ancient Times to the Present Day.
Cardiff: University of Wales Press, 2002.

Demirguc-Kunt, Asli, and Ross Levine. Financial Structure and Economic

Growth: A Cross-Country Comparison of Banks, Markets, and
Development. Cambridge, MA: MIT Press, 2004.

Eagleton, Catherine, Jonathan Williams, Joe Cribb, Elizabeth

Errington,. Money: A History. Richmond Hill, Ontario, Canada: Firefly
Books, 2007.

Eichengreen, Barry. Globalizing Capital: A History of the International

Monetary System. Princeton, NJ: Princeton University Press, 2008.

Ferguson, Niall. The Ascent of Money: A Financial History of the World.

New York: Penguin Press, 2008.

Homer, Sidney, and Richard E. Sylla. A History of Interest Rates, 4th ed.
Hoboken, NJ: John Wiley and Sons, 2005.

Hummel, William. Money: What It Is, How It Works 2nd ed. Bloomington,
IN: iUniverse, 2006.

Meltzer, Allan. A History of the Federal Reserve, Volume 1: 1913–1951.

Chicago, IL: University of Chicago Press, 2003.

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