In the first installment of this series, we tackled the question: “What is money?” To reiterate, money is a medium of indirect exchange and satisfies the double coincidence of wants. Next, we will tackle the question: “What makes good money?”
Throughout history, many commodities have been used as money: Ancient Sumerians monetized clay tokens, Native Americans used strings of quahog shells (wampum), and at times, southern colonial Americans used tobacco. However, some of the most common–and most successful–monetized commodities are precious metals . . . specifically gold and silver.
Which commodities make the best money, and why does the market choose silver and gold?
In order to be successfully used as money, a commodity must: 1) be in high demand, 2) be highly divisible, 3) retain its value when divided, 4) be portable, with a high value per unit weight, and 5) be highly durable. (These factors taken directly from pgs. 6-7 of The Mystery of Banking)
Because of their ability to satisfy these qualities, markets have historically selected gold and silver as the best commodities for use as money. Because of their scarcity, silver and gold are almost always in high demand. Their chemical properties cause them to be highly malleable, and allow them to retain their value throughout division. Gold and silver coins have a high value per unit weight, enough so that they may be conveniently carried on one’s person. Unlike wampum or tobacco, gold and silver coins retain their value indefinitely and are easy to test for legitimacy.
Recently, the world has popularized the use of bank notes instead of gold and silver. Bank notes are not commodity money, because they have no intrinsic value. Bank notes (when redeemable) merely represent a promise to pay a debt with money. In essence, they are fancy IOUs.
In 1971, the United States completely severed the dollar’s connection with gold, switching it from a representative currency (currency that is redeemable) to a fiat currency. This simply means that the dollar is not redeemable in gold and therefore has no intrinsic value. It is simply state-issued “Monopoly” money.
The Keynesian justification for this removal of intrinsic value is that it gives money “flexibility.” Simply speaking, it allows for easier “money creation.” For those of us that know better, it allows central bankers, (for us–the Federal Reserve) to create money out of thin air.
In this installment, the second in our “Money: The Basics” series, we tackled the question “What makes good money?” In doing so, we have added to our definition of what (commodity) money is: a medium of indirect exchange which satisfies the double coincidence of wants, and that has intrinsic value in addition to its value as money.
In our next installment, we will discuss how governments ruin money. Thanks for reading!
Once again, for a more in-depth analysis of money and other associated topics, please refer to the experts through my Amazon affiliate links (you’d be helping out a poor law student in the process):
The Mystery of Banking; Murray Rothbard Chapter I: Money–Its Importance and Origins
Principles of Economics; Carl Menger Chapter VIII: The Theory of Money