Hard Money Diploma · Module 2: The History of Money

2.0 Introduction

Imagine a time long ago when people didn't have the coins or paper bills we use today. Back then, they had a unique way of trading things: using items like shells or precious metals like gold as a kind of special currency. This was their version of money, something everyone agreed had value.

In this module, we will embark on a journey through time, experiencing the evolution of money firsthand. We'll trace its origins and observe how it has changed and adapted throughout history.

Activity: Iterative Barter Game

A class exercise to increase understanding of bartering concepts. Participation helps you see how money naturally develops in free markets.

2.1 From Barter to Modern Currency

Problems with Early Forms of Money

In a barter economy, people trade goods and services directly with each other. For a trade to happen, each person must have something the other wants. This creates a problem called the double coincidence of wants: both people must want exactly what the other is offering at the same time. Because this rarely happens, barter becomes very inefficient, especially as societies grow larger and trade becomes more complex.

Let's suppose: Joseph has a banana, but is in the mood for coconut. Yael has a coconut, but she doesn't like bananas and would prefer a mango. Tammy has a mango but will only trade it for a papaya, and papayas don't grow on that island. Joseph can't trade with Yael because she doesn't like bananas. Yael can't trade with Tammy because Tammy won't take her coconut. Tammy can't trade with anyone because no one can access papayas.

They're stuck: there is no way to complete a trade chain that leaves anyone satisfied. Joseph sighs: "If only we had something everyone would accept in exchange, like a nice cold soda." They all nod, realizing this is exactly what money does.

2.1 From Barter to Modern Currency (continued)

Development of Coinage and Paper Money

As a community becomes more involved in trade, the limitations of bartering push it toward an intermediary good to serve the functions of money. This is commodity money.

As metal coins get used more, drawbacks appear: they are heavy and inconvenient in large transactions, and some people commit fraud by melting coins down and remaking them with cheaper metals mixed in. This lowers the coin's real value relative to its nominal value and undermines trust in the whole monetary system.

To address this, communities begin using paper receipts representative of the value of metal money. These receipts, with origins in Ancient China, are convenient and easily exchangeable. They are backed by gold and other valuable metals and can be converted into these metals, as they were from the 17th to the 20th century.

2.1 From Barter to Modern Currency (continued)

Transition from Sound to Unsound Money

Fast-forward to the 17th century in Sweden: communities become completely dependent on banks to store valuable assets. But something fishy is going on. Bankers are issuing more paper receipts than they have gold in storage, creating more money than they have assets to back it up, and profiting from the difference.

This marks a major shift: moving from sound money (backed by precious metals) to unsound money (fiat currency not backed by a physical commodity). This didn't happen overnight. The industrial revolution, mass production, urbanization, and the growth of banks and stock markets all played a role, as did the emergence of central banks that centralized control of money.

Until World War I, paper money could be converted into a preset amount of gold. The two world wars and the 1929 economic crisis put an end to that. In 1944, the Bretton Woods agreement established the U.S. dollar as the world's reserve currency, fixing its value to gold at $35 per ounce, with other currencies pegged to the dollar. The system began breaking down in the late 1960s, leading to the Nixon Shock in 1971, when the US government suspended the dollar's convertibility into gold. This marked the end of the gold standard.

Despite efforts to improve quality of life, the standard of living for the majority begins to decline due to abuse of centralization, rising prices, stagnation of real wages, weakening currencies, and the need to spend more money for fewer things. This creates challenges for those with fewer economic resources, and the rich seem to keep getting richer while the poor seem to keep getting poorer.

2.1 From Barter to Modern Currency (continued)

Paper to Plastic

We've come a long way from the introduction of the first credit card back in the 1950s. Today, with a simple swipe or a contactless tap, purchases happen without any hassle. But reliance on credit has painful aftereffects, like raising the overall cost of goods and incentivizing an economy doomed to fail.

As technology advances, so does the way money is handled. The internet has become a central tool in the financial world, with online banking and e-commerce making it possible to manage and spend money entirely online. The rise of digital money marks the next significant leap in this evolution.

2.2 Digital Currency

Unlike traditional monies, digital currencies exist solely in electronic form. They are stored and exchanged using computers and special software. Much like how email allows us to send and receive messages instantly and without shipping costs, digital currencies make it possible to send and receive value instantaneously and at very little cost.

The currencies we use are becoming more and more digital; today, only a small fraction of the money supply remains in the form of coins and paper bills. Banks and banking services provide their customers with applications to seamlessly exchange money over the internet. But where does the money come from?

Wrap-Up and Check for Understanding