What is money? Is money simply the paper bills and notes that we use today? Is it the digits in your bank account when you check it on online? Or, is money actually something far more complicated and intriguing? What constitutes money and the nature of money would probably surprise most people, but as with most things that have to do with economics, the truthful answer is bigger than just “paper with dead Presidents on it.”
The origin of money and its uses are interesting. To begin, there are two types of exchange. There is direct exchange and there is indirect exchange.1 Direct exchange is when persons “A” and “B” exchange commodities “x” and “y” with each other. Person “A” exchanges commodity “x” for commodity “y” so that they may immediately use or consume product “y”. Person “B” has the same intention when they exchange commodity “y” for “x”. This is “direct exchange”.
Mises points out that indirect exchange is possible when there is more than two types of commodities and more than 2 people in a market. Mises explains it best here:
“Let us suppose that A brings to the market two units of the commodity m, B two units of the commodity n, and C two units of the commodity o, and that A wishes to acquire one unit of each of the commodities n and o, B one unit of each of the commodities o and m, and C one unit of each of the commodities m and n. Even in this case a direct exchange is possible if the subjective valuations of the three commodities permit the exchange of each unit of m, n, and o for a unit of one of the others. But if this or a similar hypothesis does not hold good, and in by far the greater number of all exchange transactions it does not hold good, then indirect exchange becomes necessary, and the demand for goods for immediate wants is supplemented by a demand for goods to be exchanged for others.”1
What he means to say is that, suppose the subjective value or marginal utility bestowed upon each commodity by all the actors makes direct exchange impossible. This means that each person must trade the commodities they have for transitory commodities, or commodities they specifically acquire with the intention of trading them for the commodities they desire to consume. As you can see this method analyzes “the individual and his actions and choices as the fundamental building block of the economy.”2 It puts the individual at the center, or as the progenitor of all economic activity. This is key to understanding how money comes to be.
Now the above examples of indirect and direct exchange show how both methods of exchange can fall short. It’s a hassle to find someone who has exactly what I want, and who wants exactly what I have in order to trade. It is also a hassle to make all of these trades for items I don’t want to consume in order to eventually make the trade for the item I do want. Direct exchange is out of the question as a method of finding a short cut because indirect exchange becomes necessary as the division of labor becomes more refined.1 Indirect exchange can still work if there is a common medium of exchange i.e. money, “Thus along with the demand in a market for goods for direct consumption there is a demand for goods that the purchaser does not wish to consume but to dispose of by further exchange.”1 This is how money came to be in the forms of gold and silver.
Both gold and silver were rare materials that had functions outside of money, such as jewelry and other such products, therefore it functioned well as a valuable, rare but not too rare, medium of exchange. A commodity that was widely accepted for other goods. This is kind of where it gets a little interesting (at least for me). Not only does the commodity used as money gain value from its secondary uses, but it also gains value from its use as money as well. This seems to develop over time.
A question still remains. How do we come to accept something as a common media of exchange? Sure, once everyone else accepts it, the individual is willing to accept it too. But how does a market get to that point? What incentive is there to accept worthless pieces of paper or metal as something that is a common media of exchange?
“It was in this way that those goods that were originally the most marketable became common media of exchange; that is, goods into which all sellers of other goods first converted their wares and which it paid every would-be buyer of any other commodity to acquire first. And as soon as those commodities that were relatively most marketable had become common media of exchange, there was an increase in the difference between their marketability and that of all other commodities, and this in its turn further strengthened and broadened their position as media of exchange.”1
Carl Menger, the founder of the Austrian School of economics, argued that money did not come about by government edicts, or anything like that. He argues that money came about spontaneously through self-interested individuals and their actions. “In order to understand how this could have occurred, Menger pointed out that even in a state of barter, goods would have different degrees of saleableness or saleability. (Closely related terms would be marketability or liquidity.) The more saleable a good, the more easily its owner could exchange it for other goods at an ‘economic price.’ For example, someone selling wheat is in a much stronger position than someone selling astronomical instruments. The former commodity is more saleable than the latter.”3
During ancient times, the various forms of money used were used as money simply because the people involved in trade had subjectively valued commodity “x” as more “marketable” than commodity “y”. Thus, commodity “x” was more widely accepted than ‘”y” meaning it had greater potential of becoming “money” within a barter system. Back then, things like gold, silver or any other precious metal, was deemed valuable and more marketable than anything else. Not only that, but it was somewhat rare, had secondary uses, and was durable. This meant that it would not degrade with time and therefore lose value.
Money did not occur because some king decided that a certain commodity should be used as money (the problem with this idea is that this ruler would have to know the exchange ratio for every commodity that it would be traded for, which is impossible). Money came about through anarchy. Money came about spontaneously through individuals trying to economize their trade. Governments only come into the equation later, usually, to mess this amazing system up.
2. Rothbard, Murray N. “Money and the Individual.” Mises Institute. Mises.org, 02 Mar. 2010. Web. 22 Sept. 2014. <http://mises.org/daily/4155>.
3. Murphy, Robert P. “The Origin of Money and Its Value.” Robert P. Murphy. Mises Institute, 29 Sept. 2003. Web. 24 Sept. 2014. <http://mises.org/daily/1333>.