05 Jun The Nature of Money
[Note from the author: This post was originally published in 2012 on a blog entitled “Further to Freedom.” This blog was an attempt of mine to communicate some of the complexities of economics in an accessible, easy-to-understand way. The blog was organized by ‘Levels’, which I thought would help readers to select articles which better corresponded to their level of economic understanding. I had originally envisioned this as a collaborative project and wanted to bring in a handful of others to contribute articles. That vision never materialized, but the time I committed writing and working on the project gave me a deeper understanding of the topics, and I’m still happy to share the work. This particular article was categorized ‘Level 1’.]
In a previous article we discussed the need for money and the benefits money offers each person that uses it. But where does money come from? How does money become established? Before we discuss various types of money, we must first consider the way that money functions and how it originates in a market.
The first quality of money is its general acceptance within the market. If Ann wants to purchase a purse from Caroline, she will need to provide a money that Caroline accepts. If polished acorns are not accepted at Caroline’s store, polished acorns will not work. Instead, Ann will use sea shells, the money that Caroline accepts. In fact, sea shells are the money that most of the stores in Ann’s area accept, so she brings only shells with her when she goes shopping. Ann spends most of the day shopping and paying with sea shells. Because of their various sizes, she is able to receive smaller shells back as ‘change’ for her larger purchases, and she can also use the smaller shells for smaller purchases, like her triple ristretto espresso.
For lunch Ann goes to a local sandwich shop that is well known for it’s quality, locally grown food. As she enters the restaurant she notices a sign, “We only accept glass beads as payment.” This presents Ann with a problem—she only has sea shells. Ann is clearly upset. She has heard so many good things about this restaurant! If the sandwiches are desirable enough to Ann, she will exchange her sea shells for glass beads so that she can pay the restaurant. The exceptional product outweighs the inconvenience of exchanging her money. On the other hand, Ann might walk out of the restaurant and eat lunch at a location that accepts sea shells as payment. The sandwiches aren’t worth the trouble. If enough customers refuse to pay with glass beads, the sandwich shop will either go bankrupt or they will begin accepting payments of a more accepted medium of exchange. In this way we see that businesses take their ‘cues’ from customers and vice versa. A medium must be generally accepted by the market for it to become money. The reverse is also true: if less and less businesses accept glass beads as payment, they will eventually fall out of usage as money and become only worth their value as a commodity.
The second quality of money is its ability to represent value. Jerry is a third-generation tomato farmer who likes to read books. He is very successful at tomato farming, and every summer most of the town purchases their tomatoes from his farm. As new books come out, the book dealer will often trade Jerry for his tomatoes—a good deal for both of them. But like most produce farms in North America, Jerry cannot grow tomatoes in the winter. He must trade some of his summer tomatoes in for a medium that will allow him to purchase new books as they come out in the upcoming winter. As he considers what medium to trade his tomatoes for, he realizes that whatever he chooses cannot be perishable (like his tomatoes) and it must maintain its value throughout the winter (so he can buy the books he wants.) Jerry decides to trade a few bushels of his tomatoes for their value in silver, which is easy to transport and store and has a history of retaining its value.
Perhaps the most obvious ‘common denominator’ of money is its practicality. The market always prefers a medium of exchange which is most widely accepted, easiest to transport, and most retains its value. Historically there have been dozens of mediums or moneys that have fulfilled these specifications. In several other articles you can learn more about different kinds of money and their use in history and today.
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