What is money: Part 1 – The need for money

Let us embark on a quest to understand money. In this first blogpost of the "What is money" series we will learn why money exists, what purpose it serves and explain why it arises naturally. In order to do that, it is important to recognize some fundamental properties of human existence.

1. We humans can think about the future. Without this ability, we would probably still gather or hunt for every single meal shortly beforehand. Like many other creatures, we would be driven by instincts and live exclusively in the here and now. The fact that we can think about the future is both a curse and a blessing. A curse, because it means we can and therefore do think about how we will make ends meet not only today, but also in the future. This brings with it a tremendous amount of uncertainty. A blessing, because we can actually find ways today, which will ensure our "making ends meet" in the future. A fundamental question of the human condition is this: "How can we work today in order to be able to do more of what we want to do instead of what we need to do tomorrow?", or in other words: "How can we be productive and shape the future?". Being productive means more freedom for us humans. Productivity saves us time and energy that we can use for other things instead. But where does productivity come from?

2. We humans are tool makers. We look at our surroundings and make use of our intellect and the available resources to make better use of our time and energy. We use tools to preserve our food, ensure hygiene, keep us warm, build houses, communicate, etc. The better the tools we use, the higher our standard of living becomes. These two fundamental characteristics describe the civilizing power of humanity. Civilization is the set of social and material living conditions created by technical and scientific progress (through the creation of better tools).

3. We humans are social beings. We always live and work together in groups. This makes sense because, for one thing, there is more than one thing that helps ensure our "making ends meet" (e.g., food, drink, roof over our heads, safety from attackers, hygiene, taking care of children, learning, etc.) and, for another, we all possess different talents and characteristics. Therefore, it makes sense that we don't all do the same work. As a species we are more productive when we specialize and divide work, which naturally creates trade to share the fruits of our labor done together. The division of labor and trade among ourselves accelerates the civilizing process immensely. This progress comes with a caveat. The more people come to work together, the more complex the trade gets.

All human cultures and societies have therefore always and naturally, whether consciously or unconsciously, arrived at the same problem:

In order to improve our living conditions, human beings need a tool... to enable us to trade with each other easily... to allow us to measure the value of our labor and compare it to the work of others and to store the value of our labor into the future?

The tool to perform these functions is what we call money. Money is therefore intrinsically linked to work and the time and energy we spend. So let us take a closer look at the three fundamental properties money should have:

• Means of exchange or payment: We need something to exchange the fruits of our work for those of the work of others. Barter can only take place if both parties desire and need the good that the other possesses. This is called the coincidence of wants. Often, however, this is not the case. In many cases, for example, I want your apples, but you do not want my bananas. The exchange into a neutral exchange medium, which everyone accepts and can afterwards exchange against all other type of goods would make trade possible in all other cases (provided this neutral exchange medium is accepted by all participating parties).

• Unit of account: To measure the value of the fruits of our labor and compare it to others. Supposing there are 100 different goods one would always have to determine a specific exchange ratio of each good with respect to all other 99 goods. With a neutral medium of exchange as a unit of calculation, it is sufficient to determine a single exchange ratio for each good (namely the one in the neutral medium of exchange). This makes it much easier and more efficient to measure and compare the various goods and labor services. In consequence trade becomes much easier.

• Store of value: To store the value of our labor over time. There is always a period of time between the moment we perform our labor and the moment we want to exchange it for other goods. But how do we know how much time can pass between our labor and the exchange of it into something else? This depends on how well the medium of exchange we chose can store the time and energy of our work. The better the value storage property of the medium of exchange, the greater the amount of time that can elapse between the performance of our labor and the exchange of it for a comparable service or good in return. The better the value storage property of the medium of exchange, the more accurate and further into the future we can plan and the less uncertainty we will feel about the future. This enables to save for particularly valuable things like for example a house or a pension.

The need for the tool we call money, arises naturally in the process of civilization of any society. As with any tools, there are bad ones and better ones. The search for what makes for the best possible tool of money resembles a natural evolutionary process, where societies chose all kind of random things as money and tried what works best.

In the next blogpost of the "What is money" series we will dive into the history and evolution of money and explore the decisive role the quality of the tool we use as money plays in the success of entire cultures and civilizations. Stay tuned!