Origins of Money
The need for money originates
with the concept of private property. If there is no concept or
convention of private property, there is no need for money. If
someone wants something they can just take it, regardless of who
has produced it. This is not very satisfactory, as those who are
strong end up controlling everyone.
If a system of private property
recegnises that people own what they produce. For this
system is to function efficiently, there must be a process for
for goods and services. It is not practical for each person to
produce everything that they need. Most people will produce more
than they need of what they are best at and exchange it for other
things that they need. For this to
work, there must be a way for people to freely and confidently
exchange the goods and services which they own.
The first method of exchange that
developed was barter. People would exchange goods by swapping with
someone who had what they want. However, barter is very
inefficient. People will waste a lot of time looking for someone
with whom to barter. Often it will not be possible to find a
person with a surplus of what I want, who wants what I have. The
person with a surplus of what I want will generally want something
different from what I have. For example, if I have a surplus of
wool and want to exchange it for food, a person who has a surplus
of food is unlikely to want wool.
The solution was to discover a
good that is accepted by everyone as having value. In some
societies this was cattle, in others it was pelts. In POW camps
cigarettes served this function.
When a commodity has this
property, I can find someone who wants wool and swap it for the
commonly accepted good, knowing that a person who has a surplus of
food will accept it in exchange for food. In this way the popular good
begins to act as a form of money. People will always accept the
good that acts as money, because they know it will enable them to
obtain the goods or services they want from others. Gold and
silver were the commodities most frequently used as money.
We can now start to see the
function of money. It may have no intrinsic value in itself. When
silver was first used as money, its only use was as a decoration.
It did not have the industrial uses it has today. However, it had
value as money, because it enabled people to obtain goods and
services that they wanted from other people.
Money entitles me to goods and
services. This is an important and basic principle. Money is
claim to goods and services, which is recognised throughout
society. If it loses this property, because the owners are no
longer unwilling to exchange it for their goods and services, it
has ceased to be money.
To function ias money a good
must have the following properties:
- It must be accepted by all
people in society
- It must be portable. (A
problem with using cattle as money is that they are hard to
take along when you go to buy some bread.)
- It must be sufficiently widely
available that everyone can hold some.
- It must be sufficiently scarce
that it retains its value.
- It must be divisible, so that
it can be used to purchase goods of different value.
- It must be permanent, so that
it retains its value if it is not spent straight away.
- It must be reliable, ie, it
cannot be counterfeited.
In most societies, the goods which
satisfy these conditions best have been the precious metals, gold
A problem with exchanging
precious metals by weight is that it is not possible for everyone
to carry a set of accurate scales. The next development was that a
few people who had a reputation for honest scales would mould the
gold and silver into coins. They would stamp the coins with a
weight and a mark, which indicated that they had certified the
weight. Provided these goldsmiths reputation for honesty
continued, their coins would be acceptable wherever their
reputation was known.
This system was self governing.
There would always be some people with scales who would check the
weight of coins. If a coin was found to be dishonest, the
goldsmith would quickly lose his reputation and his coins would
cease to be widely acceptable. Thus, he would have to remain
honest to continue in business.
The next development was for
kings and rulers to mint coins with their image on them as a guarantee of
the weight. However, there is no reason why a king should be more
honest than a goldsmith. In fact, many were not; but rulers and
kings could ensure that their dishonest coins remained in
circulation by demanding that all taxes be paid in their coins.
The power of taxation gave them a monopoly position, which enabled
them to enforce the use of false money. Privately minted coins
would generally be more reliable, than coins issued by the Crown,
as a goldsmith would have to be honest, if they wanted to maintain
There are several ways in which
precious metal coins could be devalued. They could weigh less than
they were supposed to. People could file or clip off the edges of
the coin and keeping some of the gold for themselves. This was prevented by introducing serrated edges, which
would make any effort to file off some of the metal obvious. The
most sophisticated and most difficult to detect method of fraud is
to use gold or silver, which was less than pure. Some other cheap
metal could be mixed with the gold or silver.
This debasement of a coin is theft. The debased coin has less gold than it
claims to have. The person who debases a coin in any of these
ways, is keeping for themselves gold or silver which belongs to
the person to whom they first give the coin. It is obvious
that this is stealing. The prophets condemned those who
debased their coins. Kings and rulers who allow their currency to
be debased are "rebels and thieves
Your silver has become dross,
your choice wine is diluted with water.
Your rulers are rebels,
companions of thieves;(Is
Debasement of currency is associated with spiritual
As wealth increases, owning a
large number of gold and silver coins becomes a security problem.
As coins are portable, they are also easy to steal. The next step
in the development of money was for people to leave their surplus
gold and silver coins with a goldsmith who had a reputation for
honesty and who operated premises which were secure. The goldsmith
would give a receipt, which would entitle the owner to withdraw
their coins when they needed them. This was the beginning of paper
However, after a while people
would find it simpler to exchange the receipt rather than going to
the trouble of getting the gold, giving it to another, and then
that person having to take it back to a goldsmith. Provided
goldsmiths continued to be honest and their premises were secure,
their receipts would circulate as money.
The goldsmiths would face the
temptation to use the gold for themselves. However, every now and
then people would still go and get out their gold and silver. If
it was not there, the goldsmith would be revealed as a thief and
would be punished for theft. Their reputation and their business
would be destroyed.
Gradually, the business of
issuing receipts for gold and silver, which circulated as money,
became more important than the work of measuring and weighing
gold. When this stage was reached goldsmiths had become banks.
They would issue notes of different value to make it easy for
trade in goods and services to take place.
Some of the earliest banks to
emerge were religious temples. Some of the earliest records
of gold and silver being desposited for safe keepin come
from Egyptian temples. The people caring for the temple were
considered to be honest. They often had guards protecting
the entrance from intruders so they were a relatively safe place
to store valuables. They often acted as storehouses of gold
and silver in return for a fee. This often became a
profitable activity for the priests responsible for the temple.
This may be what the money
changers that Jesus threw out of the temple in Jerusalem had been
doing. Some commentators suggest that the word translated as
"moneychanger" can also be used to describe a
banker. Jesus may have called them thieves, because they
were engaging in form of fractional reserve banking.
Fractional Reserve Banking
Modern banking came about when
bankers found that people hardly ever came and asked to withdraw
all their gold and silver. They realised that they could issue notes
in excess of the value of gold and silver they held. This could be
done by issuing loans to people who had not deposited coins. If
there was a large demand for gold and silver, the loans would be
called in. For example, over time the bankers might observe that
requests to withdraw gold and silver never exceeded more than a
quarter of the stocks held; they could issue notes up to four
times the value of the reserves of goods and silver in stock. This
is the basis of fractional reserve banking.
This practice is really a form of
theft. A person who makes a deposit of gold or silver is asking
the bank to look after the money. They have not authorised the
bank to lend it to another person. The bank has a duty to care for
the money and does not know when the depositor will want to come and take it back. In making such loans, the
bank is doing something the owner of the money has not authorised
them to do. This is dishonest.
The problems with fractional
reserve banking have been demonstrated throughout history. The
practice works as long as the flow of withdrawals and deposits
roughly match each other. In a time of uncertainty or panic, a
large number of people may try to withdraw their deposits. As
there is an advantage in getting in first, there may be a run on
the bank. If the bank cannot call up all its loans it may run out
of reserves. This could push the bank into bankruptcy and many
people would lose their money. Panics and bank crashes have been
common throughout the history of banking.
Fractional reserve banking is
very unstable and depends on the continuing confidence in the
banks. If for some reason that confidence disappears, a string of
banks can collapse.
Jesus hostility to the business
operating in the temple in Jerusalem was probably a reaction to
these dishonest practices.
To solve the problems of
instability in the modern banking system, governments have
introduced a number of controls.
First, they have removed from
banks the right to issue notes and coins. In most countries this
is now a monopoly right held by the central government. A state
bank generally has exclusive control over the issue of all
currency. This is not generally backed by gold or silver, but it
is stated to be legal tender. This means that by law, it has to be
accepted for the settlement of all debts and payment of taxes.
However, governments have
generally not been any more honest in issuing currency than the
banks. When a large volume of notes are issued, they give people a
legally claim to goods and services that do not exist. The result
will be shortages. In most cases, sellers take advantage of this
situation by raising their prices. The result is a rapid increase
in prices or inflation. Many governments have caused a serious
inflation by printing large amounts of currency to finance wars or
other activities. For example, in Germany in 1923 it cost
1,000,000,000,000 marks to buy something that cost one mark in
Inflation is a destructive force
in economy. Its worst effect is that it destroys the value of
savings. This especially effects those who are saving for their
old age. It also encourages investment in speculative rather than
productive activity. This reduces the vitality of the economy.
The second control that
governments have introduced is to establish a central bank and to
specify that reserves must be deposited at the central bank.
Instead of holding gold and silver as reserves banks now use
deposits in the central bank as their reserves. If there is a run
on a bank, they can meet the demand by borrowing from the central
bank. This has reduced the risk of panics and runs on banks.
However, this solution is really
the same as the central bank printing more money. It has made it
more difficult for the supply of money to be controlled. This has
increased the instability of the modern economy. The multiplier
effects of fractional reserve banking exaggerate the impact of
changes in monetary conditions. If left alone, it would result in
a cycle of booms associated with inflation followed by depression
Most governments are now
reasonably responsible and try to eliminate the dangers of
monetary excesses like those caused by the government in Germany.
Some try to increase the supply money gradually over time in line
with economic growth. Others try to operate a counter-cyclical
monetary policy. During times of expansion they tighten the supply
of money to prevent inflation getting out of control. During the
depressionary part of the cycle the relax monetary conditions to
reduce the depth of the recession and the effects of unemployment.
However the success of
governments in operating these policies have not been great. It is
not easy to determine what stage of the business cycle the economy
is in, so it is often not clear what policy is correct. This is
complicated by the fact that monetary changes can often take over
a year to take effect. Thus the timing of policy changes is
A further problem is that
economists have found that the money supply is almost impossible
to measure. This is partly because the boundary of what is money
is quite hard to define. New forms of money are coming into
existence all the time. For example telephone cards are now
beginning to function as a type of money.
However, if the money supply is
hard to measure, it is even harder to control. The policy changes
open to the government are uncertain in their effect. A measure of
the quantity of money in the economy gives a snapshot at a
particular point in time. (It is a stock estimate of a flow
variable) The critical thing is the flow of purchasing power.
Controlling the size of the stock of money achieves nothing. Even
if the supply is stable, the flow of purchasing power can change
depending on the speed at which money changes hands. The results
of changes in the stock of money depend on many factors that are
beyond the government’s control.
Some governments have given up
trying to control the supply of money, and instead control the
level of interest rates (and perhaps the exchange rate). However,
even this form of monetary policy is a very heavy-handed and blunt
instrument. Interest rates and exchange rates are market signals,
which assist businesses and households to make economic decisions.
Having a central bank targeting these to control inflation will
give distorted information to decision makers. The result will be
uneconomic decisions, which will result in sub-optimal economic
If there is an increase in
speculative investment or consumer borrowing which could harm the
economy, the government will increase interest rates to cool it.
The problem is that the rise in interest rates will also
discourage borrowing for productive investment, which the economy
needs. The instrument cannot be used without harming the goods
parts of the economy. In New Zealand, the Reserve Bank had had to
raise interest rates to dampen speculation in the
property market, doing great damage to the rest of the economy.
In the 1970s, Sir Robert Muldoon
tried to fine tune the economy using a mix of fiscal and monetary
policy. Everyone agrees that this tinkering did not work. Fiscal
policy has now been stabilised, so that it can no longer be used
for fine tuning. We now have the absurdity of the Governor of the
Reserve Band trying to fine tune the economy using monetary policy
alone. The Reserve Bank is wanting more and more statistical
information to assist with its tinkering. This is ridiculous. If
Muldoon could not fine tune a highly regulated economy, the
Reserve Bank will not be able to control a market economy with
just one instrument.
Implementing monetary policy in a
modern economy is like navigating a supertanker in dangerous
waters without a chart or compass and with a steering wheel that
is connected to the rudder by rubber ropes. Both are tasks, which
should only be taken on by the bold or the foolhardy. This would
be funny were it not for the effects that it has on ordinary
people. Excessive inflation destroys the savings of those who have
worked hard to provide for their future. Depression and
unemployment destroys the business and lives of many others.
Modern governments, despite making great promises, have not been
able to eliminate these curses from society.