At some point long ago money was currency and vice versa. Various reasons over the years bankers and governments have for strived to separate this connection. To the point now where for the last 40 years currency has not operated as money.
Firstly a little history
The simple history of how the banking system came to be. At some point in time not too long ago in human history, you would walk around carrying gold or other precious metals in a little bag ready to exchange at any point. If you wanted souvlaki for lunch or a new shirt for work, you would walk into a store and for the price the store owner was offering, you would take out the necessary weight in gold and hand it over for the item. This system worked well and as a result, societies were able to universally transact successfully. Both sides of the transaction had something the other saw as valuable at that specific time.
Imagine society prior to this. Let’s say you are a lawyer you walk in that shirt shop to purchase a new shirt for work. You pick one off the rack, try it on and proceed to the checkout. Upon having the item rung up on the register, the Store Owner then asks how would you like to pay. You say I’ll write you a new employee contract. Store Owner looks at you strange and rejects the transaction. The Store Owner just doesn’t have the need of the solicitors services. At least not at that specific moment. You walk out of the store deflated and without the shirt and the Owner misses out on a sale. A universal medium of exchange was needed to avoid this from happening again. As time went by humanity gravitated to the properties found in Gold, Silver and precious items to use as a medium of exchange. Plenty of other items we’re tried and tested over the years with varying successes.
Once humanity had solved this first problem it then developed another. Over time it became physically difficult to carry large amounts of gold or silver around on a daily biases, particularly if you needed to purchase larger items such as a washing machine, car or even a house. Remember this is pre zero interest finance or personal loans, where you can take it home today and pay tomorrow. So in steps a Well Dressed Gentleman to solve the problem. He offers a service where he takes your gold and stores it on your behalf in his vault and in return issues you a receipt. This receipt was a little piece of paper, much lighter than the bags of gold and entitled you to come back at any point and withdraw your gold. As you could imagine this receipt became much more convenient to swap for items than the previous system of bags of gold. Furthermore these receipts could then be made out in different denominations and combinations, as long as the total matched the amount you had stored in the vault.
Over time this worked extremely well and society again benefited, store owners thew out their scales and people forgot the old ways. Citizens could now purchase items much more easily, the little old lady didn’t have to lug around heavy bags of gold, and theft decreased as these receipts could more easily be concealed.
However as time went by the Well Dressed Gentleman saw a pattern. He realised that no one was coming back for the gold. People we’re more happy to exchange the receipts, instead of the physical gold. Before long he had an idea. ‘I could make a little extra income if I start handing out these receipts as a loan and they can pay it back over time with a little extra on top as a fee’. Of course as Well Dressed Gentleman is an upstanding citizen he will keep a balance of physical gold in the vault for those odd occasions when people do come back to collect. This led to the basis of modern banking and eventually the modern currency.
So what does this all have to do with currency and money today. Put simply money is real and currency is not. Currency is what’s called a derivative. And a derivative is something that as the name suggests is derived from another and therefore not the real item. In the story the receipts received for depositing your gold was a derivative of the actual gold in the vault at a ratio of 1:1. For every 1 ounce of gold deposited you received a receipt that stated 1 ounce. If you deposited 10 ounces you could have had the receipt made out to say 10 ounces and so on. The receipt that we’re handed out as loans we’re also derivatives. The difference is they were derived from the pool of gold that was already existing. Essentially other people’s gold.
The modern currencies of today operate on a simular principle and have for a along time abandoned 1:1 ratio. For every ounce of gold in the vault of the leading central banks there is not the equivalent in value dollars, pounds, franks, yen or marks in existence. So by their very nature the currency is a derivative and not real.
Of course, this is a very broad and general overview of the system and I encourage you to view Mike Maloney’s – Hidden Secrets of Money series as it is an excellent foundation. The purpose of this little history piece is to lay the foundation for part 2. What are the characteristics that make money real.
Modern Currencies vs Money
As humans we expect currency to do a number of things on a daily basis, such as be a means of exchange, unit of account and a store of value. Without these it would be useless and we would head back to bartering as pointed out in the story. Although the modern currencies fulfil these important needs in some way there are seven characteristics that can be use to identify money versus currency.
Although money was invented over 4000 years ago when the Egyptions first used gold to transact it was Aristotle (B. 384 BCE, D. 322 BCE) the Greek philosopher, who explored the concept of sound money understood that money needed to meet a certain criteria in order for society to function. He explains that money was introduced to satisfy the requirement that all items exchanged must be comparable in some way. Aristotle saw how through different mean than are used today the Greek empire was crumbing due to the abuse and devaluation of the money supply. As a result he developed four of the seven points.
Aristotle recognised that sound money needed to be durable, portable, divisible and poses intrinsic value. When he wrote the first four characteristics he couldn’t of had the foresight to see how money, or more accurately currency was going to be used and abused today. This is what the the last three points are devised by modern economist in the last century or two. Depending on the circle of influence they are constantly debated as to their validity. These final points are Medium of Exchange , Unit of Account, and Fungible.
Now we will go onto explain these characteristics in more detail.
The seven points in further detail
Generally speaking money must stand the test of time and the elements. It must not fade, corrode, or change and is why wheat, corn, rice and tulip bulbs are not good uses of money. Although, some money is made from a paper source, great effort is taken to develop anti-wear and tear properties. If money was to be easily destroyed or damaged you would think it may be fraudulent and therefore cannot be trusted.
Money is to hold a high amount of worth relative to its weight and size, and is therefore easy to carry around. This is why we don’t use lead, copper, oil or even property. It is necessary for money to be easily transported so that people can make transactions on a daily basis.
Can be divided into small units without affecting its fundamental characteristics. Which is why art cannot be used as money. Money needs to be easily divided into smaller denominations for the variety of daily transactions.
4. Intrinsic value.
Money should have value independent of any other object. Two parts, money should not have to have anything too it to make it worth something, and it should also be scarce enough to be valuable. This second point is why we don’t use shells, sand or pebbles from a beach.
5. Medium of Exchange
Money must be recognised and accepted by everyone in the economy to make transactions. This can happen on a country level as well as internationally between countries. The new cryptocurrencies that have been development such as Bitcoin currently fail on this point.
6. Unit of Account
Sometimes described as Uniformity meaning all money within that specific country must look the same. This allows for money to be counted and measured quickly and accurately, and is why shells, sticks and stones are bad forms of money. It is a little hard to measure the shape and weight of shells quickly.
Otherwise know as interchangeable meaning a dollar in my pocket is identical in purchasing power as the dollar in your pocket. This can also be explained in that a currency from the same issuing bank has the same purchasing power in part combinations. For example if you loan someone a $20 note, you don’t mind if they pay you back with a $10 and two $5 notes. However if you loan a car you do mind what car come back. Even if it’s the same make and model.
Only Gold and Silver fit all seven characteristics historically and today.