Fiat Currency: The Evolution Of Money

June 8, 2014 | Author: | Posted in Finance

Habit is a funny thing. On the one hand, it allows us to get through our day without having to waste brainpower on all kinds of mundane activities. Once you’re accomplished at it, you don’t think about how to drive your car, check your email, or even walk upstairs. These activities are etched into your neural synapses as an automatic program.

Everything in life though involves trade-offs. So, it shouldn’t be surprising to learn that our propensity for habit also has its drawbacks. This propensity for habitual thinking inclines us toward a tendency to accept the given as natural. Popular attitudes toward the nature of money are a case in point.

If queried for an explanation of money, most people would refer to pieces of colored paper or metal coins. Some might be a little more sophisticated and mention the purchasing power encoded in the magnetic strips on the back of rectangular plastic cards they have in their wallets. Though, the latter is basically just an accounting device for the former.

And it’s not that those answers are exactly wrong. Etymologically, the English word “money” is traced back to the minting of coins. To let such an association pass at that would be though a significant categorical error. After all, the coins of our ancestors – unlike ours, and our paper currency, today – had a value that was derived from market supply-and-demand processes.

Those coins were literally composed of precious metals: e.g. silver or gold. The amount of rice or cotton or saffron a coin could purchase was determined by the value of the specific amount of precious metal in it, as priced by the valuation of the supply-and-demand process of the market. Thus, we can see that money was really just another exchange commodity. And like any exchange commodity it was valued for its benefits. Money was money though because it had a special quality.

Historically, in fact, all kinds of things have been used as money, in this deeper sense: from sea shells to cattle. At various times, in different places, the role has been played by salt, peppercorns, grains, tobacco and copper: a list which only scratches the surface.

These commodities were embraced as exchange commodities because they were widely sought out. If a carpenter built a table and wanted to trade it for chickens, he might have a hard time finding a chicken farmer who just so happened both to have chickens to sell and was in need of a table. However, given the much more common need of salt, not only for flavor, but as a preservative, it was much more likely to find a chicken farmer in need of salt.

Additionally, the popularity of salt increased the prospects of finding someone holding some salt in need of a new table. All considered, then, there would be good sense in the carpenter converting his table into salt, and likely increasing the number of chicken farmers with whom he could trade.

Facilitating exchange between traders with incompatible preferences was the virtue of exchange commodities as currency. (Take note, though, all the items involved – tables, chickens and salt – were valued by market supply-and-demand.) Over time, pretty much everywhere, once they were available, precious metals became the money of choice. They were both widely and highly valued, which allowed for small amounts, with high value, to be easily transported. Additionally, they were subject to precise measurement, easily molded into convenient shapes and sizes, and able to be stamped with the information of their proportions.

Despite all these virtues, though, not all has been well in the world of precious metal money. The fact that everything has its trade-offs has provided no exception in its case. The downside hasn’t been in market utility, but rather in the convenience they provide to those who would coercively exploit market processes. At the risk of stating the obvious, those who have ruled human societies since the agricultural revolution have generally done so at the end of a gun barrel (or sword, or spear, etc.) The armies required for such coercive rule are maintained by the money to pay the troops who do the weapon pointing. History reveals that a favorite method for procuring the requisite funds has been plundering the currency.

Coercive rulers claim control over the money supply (which is usually not too difficult to do when you have the majority of guns – or swords or spears, etc.). Once in control of the coins, they debased the currency. The most popular practices for such debasement have been either clipping the edges of the coins or recasting them with reduced proportions of the precious metal that ostensibly gave them their original market value. In any case, the coercive rulers kept the “excess” precious metal, generated by their currency debasement, to spend on their armies.

The result was coins whose actual value in precious metal was less than the value claimed by the official stamp of the mint on the coin. The value was determined not by the market, but by the fiat, or legally binding assertion, of the ruler. All kinds of calamity and shenanigans have ensued. Indeed, nothing less than the fall of the Roman Empire can largely be attributed to such fiat currency abuses.

This story points to the origins of monetary inflation. Understanding fiat currency means understanding inflation. That’s a story we’ve told elsewhere, Understanding Fiat Currency and the Inflation Beast . And it’s a story you have to understand to appreciate the circumstances of our fiat currency, today.

Don’t let fiat currency destroy your family’s savings; follow the latest news relevant to protecting yourself and your loved ones at The Fiat Currency Review . Wallace Eddington’s recent article on Bitcoin exchange trading funds has been taking the Internet by storm: don’t miss it!

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