A classic article from 2012 on the origins of money from Economics and Liberty:
Money is primarily a medium of exchange or means of exchange. It is a way for a person to trade what he has for what he wants. Ideal money has three critical characteristics: it acts as a medium of exchange; it is an economic good; and it is a means of economic calculation.
Medium of Exchange
To properly understand money as a medium of exchange one must first go back to the first methods of trade. Before money was invented one would have to engage in direct barter. A farmer who produced grain – but wanted shoes for his family – would have to find someone who, a) had shoes and, b) wanted grain. You can imagine the difficulty involved in finding that perfect someone who had what the farmer wanted and wanted what the farmer had.
Out of necessity, this gave rise to indirect barter. Continuing with our example above, let’s assume that the farmer found a shoemaker but discovered that the shoemaker did not want grain – he wanted candlesticks. While having a drink at the local pub he overheard the gentleman next to him lamenting that he needed grain in exchange for his candlesticks. Naturally, the farmer traded his grain for the candlesticks and went back to the shoemaker and traded the candlesticks for shoes. In this example, the farmer performed indirect barter when he used the candlesticks as a medium of exchange.
Over time, different commodities served as medium of exchange but the problem of marketability and durability came into play. A necessary and highly exchangeable commodity was food. The problem is that it was perishable. One had to either use it or trade it before it went bad. Over time, the most marketable and durable commodities came to be used as medium of exchange – commodities such as gold and silver. Since gold and silver did not rust nor rot they were ideal economic goods. Over time they became the preferred medium of exchange.
Money is an expression of exchange value (the exchange values placed on goods by traders in the marketplace). In our examples above, it was extremely inefficient to express the exchange value of goods in units of sacks of grain, shoes, or candlesticks. Out of necessity the market gravitated toward the use of the exchange value of fixed weights of gold and silver. As an example, the original U.S. Silver Dollar was modeled after the Spanish Dollar which had a specific weight of silver (371 4/16th grains of pure silver or 416 grains of standard silver). A simple method of economic calculation consisting of weights and measures greatly improves trade and fosters economic growth.
What is the best form of money?
In actuality, the best approach is to let the people (the free market) decide what they want to use as money. There is no need for a central bank, government control, or legal tender laws. History has shown that, when left up to the people, silver and gold tend to gravitate to the role of money for the following reasons:
1. scarcity – supply cannot be manipulated like fiat money which causes the boom and bust cycles in the economy
2. durability – gold and silver will not rot which makes them a great store of value
3. fungible and divisible – they can be divided into small, interchangeable amounts which make them ideal for trade.
4. portable – Their high concentration of value allows you
to carry and store substantial value
5. proven – gold and silver have been used as money for over 6000 years of recorded history.
6. use value – both gold and silver have tremendous use value in industry. The highest use value though is in their role as money
A new currency named “bitcoin” is generating much interest due to its similar characteristics (see Bitcoin: A New Commodity Created To Serve Market Demand and Further Observations On Bitcoin, Digital Currencies, Privacy and Liberty)
Purchasing Power Can Rise Over Time with Honest Money
Honest Money (defined as a medium of exchange consisting of real goods that are in limited supply) can actually increase in value over time. Let me explain. When the production of other economic goods grows at a faster rate than the supply of money (mined gold for example) the money can buy (be traded for) more of these other goods (money supply divided by the total number of goods). This means that it could actually pay to save your money because it can increase in exchange value over time. This also means that nominal wages could decrease over time while real wages increase (your paycheck “amount” drops but your purchasing power increases).
Why and how did Government Money supplant Gold and Silver?
Laziness and deceit. The first bankers were the goldsmiths. Miners would bring the gold to the goldsmiths for minting. The goldsmith would give the miner a receipt that he could redeem when the minting was completed. The miner soon found that he could immediately trade his receipt (his claim on the gold) for tools and supplies and return to the mines without having to wait for his gold.
Over time, the goldsmith found that the receipts he issued stayed in circulation and were being used as medium of exchange. Only a small percentage of the people ever came in to redeem the receipts. To increase his purchasing power he simply began to issue his own fraudulent receipts (that had no gold backing) and used them to acquire goods and services. This increase in the number of outstanding receipts created inflation and lessened the value of all of the other outstanding receipts.
In later days, central banks did the same thing. They issued more receipts (paper currency) than they had the gold and silver to back it. The U.S. paper currency was originally a receipt for gold or silver. Take a look at the five dollar silver certificate below. Notice the words “This certifies that there is on deposit in the treasury of the United States of America five dollars in silver payable to the bearer on demand.”
In March 1964, Secretary of the Treasury C. Douglas Dillon halted redemption of Silver Certificates for Silver Dollars effectively breaking the contractual terms of the Silver Certificates.
Here is an image of a Gold Certificate:
The gold certificate was used from 1882 to 1933 in the United States as a form of paper currency. Each certificate gave its holder title to its corresponding amount of gold coin. Therefore, this type of paper currency was intended to represent actual gold coinage. In 1933 the practice of redeeming these notes for gold coins was ended by the U.S. government and until 1964 it was actually illegal to possess these notes (in 1964 these restrictions were lifted, primarily to allow collectors to own examples legally, however the issue technically converted to standard ‘legal tender’ with no connection to gold). When U.S. paper money was modernized (made smaller, with fewer variations or “types”, as with current paper money) in 1928, gold certificates ceased to be issued.
In essence, the goldsmiths (central bankers) reneged on their promise to honor their warehouse receipts and effectively stole the gold and silver that was owed to the populace. It was laziness on the part of the populace to blindly trust the central bankers with their money and deceit on the part of the central bankers when they reneged on their promises. The central bankers were now able to expand and contract the supply of money (nonredeemable certificates) to exert their power and influence over the populace.
Criticisms of Gold and Silver as Money
A common and misguided criticism of the use of gold and silver as money is that “there isn’t enough to go around”. Let’s answer that here:
Gold and Silver are easily divisible in their physical form and, when combined with technology, infinitely divisible. Services like GoldMoney.com and BullionVault.com store the gold and issue digital warehouse receipts. These receipts are a claim on the gold held in storage. These digital receipts can be mathematically and infinitely subdivided and then traded. Like all services that offer to store your gold you must do your due diligence as to the integrity of the service provider and recognize that fraud can still occur. Spread your stored holdings among competing service providers so that your risk is reduced and, by all means, keep a substantial portion in physical form within your possession. Also, note that both GoldMoney and BullionVault are subject to attack due to their centralized nature. A new, non-gold currency with gold-like attributes is emerging and showing much promise (see Bitcoin: A New Commodity Created To Serve Market Demand)
Another common criticism is “those with the gold will not want to part with it”. Here is the answer:
You can’t eat gold. Those with the gold need other goods and services. In order to obtain these other goods and services they have to trade their gold. That is the beauty of the free market. People are free to trade what they have for what they want.
The market always decides what is the best form of money. In fact, it is deciding right now – despite government intervention. One need only look at the exchange value of gold and the emergence of free-market currencies as evidence.
When people say “the price of gold is going up” they have it all wrong. It is the value of paper money that is going down.
One only needs to judge a paper currency like they would a stock. When you look at a stock you look to the balance sheet and the management of the company in order to decide what value you would place on that stock.
The same goes for a national currency. Look at the balance sheet and the management of the country and that will determine the value of the currency. The dollar is the common stock of the United States. When they issue additional stock (print money via the Federal Reserve) they dilute the value of all the other outstanding stock (inflation).