How money originated and why our relationship with money is driven by the stories we tell.
In this episode you’ll learn:
- How money originated.
- Why most money is virtual.
- Why the worth of money fluctuates both in the market and in our minds.
- How the stories we tell define our relationship with money.
The Story of Money
There is a story about money and how it started that economists tell. It is more of a myth. The story goes that in the beginning there was the barter economy where people traded what they had for what they needed. These trades could get complicated as perhaps the thing you had to trade wasn’t desired by the person who had the thing you wanted. So it might take several trades before you could arrange the deal.
Adam Smith in his book “Wealth of Nations” published in 1776 was one of the first to share the creation myth of money where the desire to exchange and specialization of labor by North American Indians and other cultures first led to bartering and eventually to currency in the form of something precious that everyone wanted that could be used to facilitate trade.
The initial currency might be shells or hides or sugar but at some point the people settled on precious metals, first in the form of irregular ingots, and in time standardized coins.
The problem with this story is there is no evidence to support it.
Sumer is one of the first documented ancient urban civilizations. It existed in southern Mesopotamia (within present day Iraq) around 3,500 BC.
The Sumerians had vast temple and palace complexes that were staffed by thousands of craftspeople, farmers, shepherds and bureaucrats.
The Sumerians wrote on clay tablets in cuneiform script. Much of what they wrote were business contracts evolving the workings of the temple and palace complexes documenting debts owed, such as rents, fees and loans.
These debts were denominated in silver shekels with one shekel equivalent to a bushel of barley. The debts were rarely settled in silver, though. They were paid with barley, goats or even furniture.
Why? Because there wasn’t much silver and much of what existed was closely guarded within the temple walls.
The First Money In Circulation
A debt is a promise to pay. And the holders of these promises (i.e. promissory notes) could sell them to someone else in order to buy goods or pay other obligations. In other words, promissory notes were one of the first forms of circulating money.
But most money didn’t circulate. It was simply accounting records, documenting debts and assets. It was virtual. Something as simple as a tab at a tavern or store is an example of virtual money.
5,500 years ago money was not coins but credit. Coinage didn’t come into existence until around 700 BC.
Money Is Trust
Systems of credit depend on trust. The anthropologist David Graeber writes in his book “Debt: The First 5,000 Years,” “The value of a unit of currency is not the measure of the value of an object, but the measure of one’s trust in other human beings.”
That is no different from today. Money is trust. And most money is virtual, units of accounts documenting who owes what to whom.
The biggest difference between the financial system today and the Sumerian economy is the complexity of business contracts. While simple promissory notes still exist, now we have repurchase agreements, reverse repos, credit default swaps, collateralized debt obligations, and many other esoteric financial instruments.
Still, even these complex vehicles depend on trust.
The State’s Money Monopoly
Circulating money in the form of coins and paper currency has always been just a small fraction of the amount of virtual money used to account for assets and debts.
Graeber points out in his book that during the reign of Henry II around 1160 AD most businesses, governments and households kept their accounts using the monetary system established by Charlemagne 350 years earlier that denominated assets and liabilities in pounds, shillings and pence even though none of Charlemagne’s actual shillings and pence coins remained in circulation.
This suggests it doesn’t really matter what money’s unit of account is as long as there is agreement. And the entities that do the most to ensure agreement on the proper unit of account are federal governments. They do this by demanding taxes be paid in the nation’s domestic currency.
Graeber writes in regards to currency, “It makes no difference whether it’s pure silver, debased silver, leather tokens, or dried cod—provided the state is willing to accept it in payment of taxes. Because whatever the state was willing to accept, for that reason, became currency.”
It isn’t even necessary the currency used for accounting matches the currency used to pay taxes or the currency in circulation, but it is certainly more convenient if it does match. That is why employers tend to pay their workers in whatever currency the state demands for payment of taxes.
One aspect of money that has been there from the beginning is the need to determine money’s worth. The Sumerians designated a silver shekel to be worth one bushel of barley. For much of the twentieth century, $35 dollars was worth an ounce of gold.
The fixed exchange rate between the dollar and gold ended in 1971, primarily because there were too many dollars and not enough gold, making it difficult for the Nixon Administration to keep the price of gold in dollars from climbing.
In retrospect, that is unsurprising seeing that gold has to be discovered and mined while the supply of dollars is potentially unlimited as new dollars are created whenever banks make a loan.
Now the value of the dollar floats relative to other currencies and commodities as investors, businesses, governments and households constantly make judgments as to the worth of various forms of money relative to each other.
Those that worry that a particular currency is going to collapse must always take a step back and ask, “Collapse relative to what?” When a currency declines in value, it means another currency is strengthening.
Since most money is virtual and used to value assets and liabilities, the value of a nation’s currency is heavily influenced by what investors’ believe they can earn investing in a nation’s assets compared to what they can earn elsewhere.