April 6, 2008

History of Money

In Indian National papers there have been articles discussing whether Gold is a safe haven for investors. With western countries undergoing serious financial meltdowns and banks failing – people are seriously questioning the intrinsic value of money in the form of currency. I recall about fifteen years ago Sri Sathya Sai Baba is reported to have advised students that: “In the future there will be a world financial crisis, so don’t leave your money in Banks or Trusts, decide where you want to be and make yourself as self sufficient as possible.’

In this respect Land and Property are the two items with the most intrinsic value – because with them you have a place to live and where to grow food. It certainly would be grand to have that safe haven situated here at Arunachala! Anyhow curious as to the history of gold and the financial underpinning of ‘society’, I decided to do some research:-

The history of money consists of three phases:

(1) Commodity money, in which actual valuable objects are bartered
(2) Representative money, in which paper notes (often called 'certificates') are used to represent real commodities stored elsewhere; and finally
(3) Fiat money, in which paper notes are backed only by the traders' "full faith and credit" in the government, in particular by its acceptability for payments of debts to the government (usually taxes).

Money is a crucial command post of any economy, and therefore of any society. Society rests upon a network of voluntary exchanges, also known as the "free-market economy"; these exchanges imply a division of labour in society, in which producers of eggs, nails, horses, lumber, and immaterial services such as teaching, medical care, and concerts, exchange their goods for the goods of others. At each step of the way, every participant in exchange benefits.

Direct exchange of goods and services, also known as "barter," is hopelessly unproductive beyond the most primitive level, and indeed every "primitive" tribe soon found its way to the discovery of the tremendous benefits of arriving, on the market, at one particularly marketable commodity, one in general demand, to use as a "medium" of "indirect exchange." If a particular commodity is in widespread use as a medium in a society, then that general medium of exchange is called "money."

Throughout history, two commodities have been able to out compete all other goods and be chosen on the market as money; two precious metals, gold and silver (with copper coming in when one of the other precious metals was not available). Gold and silver abounded in what we can call "moneyable" qualities, qualities that rendered them superior to all other commodities. They are in rare enough supply that their value will be stable, and of high value per unit weight; hence pieces of gold or silver will be easily portable, and usable in day-to-day transactions; they are rare enough too, so that there is little likelihood of sudden discoveries or increases in supply. They are durable so that they can last virtually forever, and so they provide a sage "store of value" for the future. And gold and silver are divisible, so that they can be divided into small pieces without losing their value; unlike diamonds, for example, they are homogeneous, so that one ounce of gold will be of equal value to any other.

But "gold bugs" are not fetishists; we don't fit the standard image of misers running their fingers through their hoard of gold coins while cackling in sinister fashion. The great thing about gold is that it, and only it, is money supplied by the free market, by the people at work. For the stark choice before us always is: gold (or silver), or government. Gold is market money, a commodity which must be supplied by being dug out of the ground and then processed; but government, on the contrary, supplies virtually costless paper money or bank checks out of thin air.

But if government manages to establish paper tickets or bank credit as money, as equivalent to gold grams or ounces, then the government, as dominant money-supplier, becomes free to create money without cost and at will. As a result, this "inflation" of the money supply destroys the value of the dollar or pound, drives up prices, cripples economic calculation, and hobbles and seriously damages the workings of the market economy.

To read more about finances and gold check out
‘Taking Money Back’ by Murray N. Rothbard and ‘Mundell on Gold’ based on the theories of Robert Mundell.

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