What is money: Part 2 – The history of money: From pearls to gold

In this blogpost we start exploring the history of money and the examine the role money plays in the success of civilizations.

In the first part of the “What is money” series we discussed why the tool we call money is necessary for human progress and therefore arises naturally. In the process our initially fuzzy question "What is money?" has evolved into a more detailed one, namely: What is the most effective tool that enables us to trade with each other easily, allows us to measure the value of our labor and compare it to the work of others and empowers us to store the value of our labor into the future?

Random tools of money

In schools in the 21st century, Pokemon cards, Panini stickers, or Diddl blocks have been used as money. In prison sometimes cigarettes serve as money. On the surface, all kinds of things can serve as money, because many things are well suited as a medium of exchange. Money as a medium of exchange is usually the first thing people think of, when they hear money. Many different things have been tried as money, because when we think short-term, the role of money as a unit of account and a store of value is less important. What works long-term, we had to find out through a long process of trial and error.

What past cultures therefore used all kinds of random things as money, such as grains of rice or glass beads. The longer we use a certain form of money, the more we notice that although many things can be used as a medium of exchange, some things simply work inherently better as a store of value over longer periods of time than others. Grains of rice for example go bad if they are not stored in an airtight and dry place. In comparison with rice, glass beads were clearly the better option, because they lasted longer. After some period of time, the people who made bad choices for their tool of money, such as grains of rice, ended up losing their wealth compared to the people who used a type of money that lasted longer, such as glass beads. People started to notice patterns and switched to the better suited tool of money.

Human beings naturally seek out the money which best performs its intended functions. There is a competition between all of the things that can be used as money. If I find the money you are using fulfills its functions better (your social and material living conditions develop better over time) compared to my living conditions with my money, then two forces collide. On the one hand, you will not want to exchange with me anymore, because my money is less suitable than yours, and on the other hand, I will want to use your money for the same reason. The search for a good tool of money therefore follows a pattern, an evolutionary process that has played out for every civilization throughout history.

Competing tools of money

Let’s come back to the example of aggry beads. Aggry beads were used as money in ancient West Africa. They could easily be used a medium of exchange. In the region they were relatively scarce due to the lack of glass production technology. For centuries they therefore worked well as a unit of account and as a store of value.

When the Europeans came to Africa they disrupted the controlled environment and things changed drastically. They noticed that aggry beads where used as money, so they took some of the pearls back to Europe and used their advanced glass production technology to mass produce them. They then took those cheaply produced pearls, brought them back to West Africa and took advantage of the African people. Europeans benefitted from their privileged position and introduced more and more aggry beads into the local economy. They exchanged the pearls for the land, houses and resources of Africans, who did not notice that aggry beads were compromised as a tool of money. They had lost their scarcity and in consequence their ability to store the value of the work, time and energy of the African people. The Europeans never really looked at aggry beads as money, but more as a tool for the confiscation of the West African territory and the enslavement of its people.

Europeans used the counterfit pearls to get things in return but would not ever take them in exchange for something valueable of their. They only accepted aggry beads as payment for small things so that the African people did not get suspicious of what they were doing too quickly. Eventually they only excepted their own money: coins made of various types of precious metals. These were (compared to the African pearls) harder to reproduce and served as a superior store of value. All the aggry beads the African people amassed eventually became worthless. This is the way different tools of money competed against each other and explains how certain types of money spread across the globe. It is no coincidence that there are multiple countries using pesos, pounds, dollars or francs. The ability to produce and destabilize the opponents money has always been a superweapon in the conquest of expanding empires.

Human beings naturally try to make more of the thing that is being used as money because it gives them an advantage. If the thing that serves as money can be easily produced by one group of people while another group has to work for it, it essentially means that one group is working for the benefit of the other. Wealth is being transferred from those who cannot produce the money to those who can. The time and energy of those who cannot (or are not allowed to) produce it, are being confiscated by those who can.

Emerging characteristics of good money

When we talk about money, we quite often ask ourselves the question, what intrinsic value does money have? Money, just like all other areas of the economy, is not primarily about intrinsic value, but rather about (real as well as perceived) scarcity. If intrinsic value were important, we would all pay for the oxygen we need to survive and let's be honest... no one would ever buy food on an airplane.

What makes for good money is that which is scarce, durable and immutable. Only what is scarce, durable and immutable can store the value of the work we have already done (and thus the time and energy we have expended) over longer periods of time. Out of all commodities on earth, heavy metals like bronze, silver and gold are the ones that are most durable, scarce and immutable. The more trade expanded, the more the different forms of money had to compete against each other. And that competition had a winner. Historically, gold has outperformed every other tool tried as money. Gold serves well as a unit of account because each ounce is assigned the same value and it remains durable over centuries, cannot be reproduced, does not spoil and cannot die. We need large amounts of energy to extract the precious metal from the ground. Gold also has a limited availability on earth, resulting in the fact that the total stock of gold in the world changes relatively little year by year and no one can easily create more of it. As we have learned in lesson 2 this has been attempted many times (most famously by alchemists), yet no one has succeeded.

A good store of value provides security and allows for more forward planning. It is hardly a coincidence that in every known prosperous society, gold has been found in large quantities. Whether it was among the Mayans or the Aztecs in Central and South America, the Chinese and Persians in Asia, the Egyptians in Africa, or the Greeks and Romans in Europe. When we use gold as a tool money, it enables us to develop and build civilizations. The social and material living conditions of societies that have used gold as money and stored the value of their labor in it, have developed better than the living conditions of all societies that have used a different type of money.

Human beings almost universally decided gold is the best money. By the 1800s the leading empires of the world adopted a gold standard as the basis for the international monetary system. This effectively made gold money for everyone who wanted to participate in trade among these countries.

I hope you’ve learned something valuable about the evolutionary process underlying the history of money. In the next episode of the “What is money” series we explore the limitations of gold and how we got to using currencies like the Euro, the Dollar or the Yen and why we created institutions such as the ECB, the FED or alike.