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 recognises that people own what they produce. For this system is to function efficiently, there must be a process for exchanging 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.

Commodity Money

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 a 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 as money, a good must have the following properties:

  1. It must be accepted by all people in society

  2. 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.)

  3. It must be sufficiently widely available that everyone can hold some.

  4. It must be sufficiently scarce that it retains its value.

  5. It must be divisible, so that it can be used to purchase goods of different value.

  6. It must be permanent, so that it retains its value if it is not spent straight away.

  7. It must be reliable, ie, it cannot be counterfeited.v

In most societies, the goods which satisfy these conditions best have been the precious metals, gold and silver.


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 their business.

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 1:22,23).

Debasement of currency is associated with spiritual impurity.

Paper Money

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 money.

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 deposited for safe-keeping 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 a 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.

Government Money

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 legal 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 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 1914.

Inflation is a destructive force in an economy. Its worst effect is that it destroys the value of savings. This especially affects 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.

Central Banks

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 and unemployment.

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 from getting out of control. During the depressionary part of the cycle, they 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 usually wrong.

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 performance.

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 New Zealand during 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 destroy the businesses and lives of many others. Modern governments, despite making great promises, have not been able to eliminate these curses from society.

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