Evolution of Money: From Gold To Paper
In the recent past, gold and silver coins were used as a medium of exchange because they were more durable and universally accepted as a medium of exchange. But they also had posed their own set of difficulties. For instances one could never be sure of the purity and the quality of the metal being offered in exchange.
This led to the use of metal coins of gold and silver being issued by the king. All coins carrying the seal of the king carried assurance of quality and weight were universally accepted as a medium of exchange.
But with the development of the printing press, this form of currencies evolved into paper currencies convertible into a previously fixed amount of gold at any time on demand. This worked well for both the people and the king. People were happy because carrying paper currency was more convenient and the king was happy because it did away with the trouble of minting fresh coins to meet rising demand.
In case of gold coins, gold supply could be increased either by procuring more gold or by lowering the quantity of gold in existing coins and by using the extra gold for minting more coins.
Gold/Silver coins etc were a natural precursor to the use of paper currency, as the value printed on it would be easily convertible to the underlying precious metal.
The second practice of lowering the quantity of gold for minting more coins is called “debasement” and one can simply print more paper currency by reducing the pre fixed amount of gold repayable against each currency. This led to era of convertible currencies, where you can convert your paper currency at any time with a previously fixed amount of another commodity such as gold.
But as you keep on reducing the pre-fixed amount of gold payable against paper currency, you reach a point when the actual gold repayable is almost negligible. They you may wonder why you should bother about keeping a paper currency that can be physically converted into gold. But people wanted to use paper currency only as a medium of exchange for other goods and services and would not have minded losing gold if they were given an assurance that paper currency would not lose its status as a medium of exchange.
It was then decided to make paper currency compulsory for all to accept the paper currency as a medium of exchange. Paper currency became a legal tender, which means that you had the right to offer the paper currency as a settlement of your debts and others are bound to accept the same. This is what led to the birth of “fiat currency”.
Gold/Silver coins etc were a naturally precursor to the use of paper currency, as the value printed on it would be easily convertible to the underlying precious metal.
Fiat currencies are worth the paper securities backing them. To print “fiat currency” it is not compulsory to have the backing of gold, it can be printed simply on the backing of government securities. So the paper currency you hold loses physical convertibility with gold, however it retains financial convertibility with government securities backing it. So you can convert you money into government securities and vice versa. But many also criticize the era of fiat currency for the unbridled increase in money supply.
Recap: Why move from Barter to ‘Money’
The process of evolution of a commodity into a money is general and universal. It occurs anytime a large group of people, trade goods and services under the barter. This process can be broken down into simpler parts:
‘Selection pressure’, the force driving the natural selection process, is the problem of a double coincidence of wants.
‘Selectors’ are the intelligent decision makers trading goods and services via a process of indirect exchange.
The selectors, guided only by experience from past transactions, will select from among competing methods of payment, those commodities that can be most easily traded for other commodities and services.
An understanding of the fundamental concepts of money i.e. medium of exchange, measure of value, and store of value etc is not required at at for this process of selection to occur. The selectors are driven only by their desire to make life easier on themselves more than anything else.
Increased selection of one commodity as a method of payment will only increases its “Preferability” as a method of payment in the eyes of the selectors. This causes a positive feedback loop to occur, causing even more selectors to select this commodity as a method of payment.
The end result of this process is that over time, an entire population of people are now buying and selling their goods and services in exchange for that single commodity only. By definition, this commodity is money, whether the selectors are aware of it or not. When a commodity is used as money, the money is called “commodity money”. Among primitive tribes, everything from shells, to cattle, to cocoa beans have been used as commodity money. Gold and silver were used as commodity money right up to the beginning of the 20th century.
In the recent past, gold and silver coins were used as a medium of exchange because they were more durable and universally accepted as a medium of exchange. But they also had posed their own set of difficulties. For instances one could never be sure of the purity and the quality of the metal being offered in exchange.
This led to the use of metal coins of gold and silver being issued by the king. All coins carrying the seal of the king carried assurance of quality and weight were universally accepted as a medium of exchange.
But with the development of the printing press, this form of currencies evolved into paper currencies convertible into a previously fixed amount of gold at any time on demand. This worked well for both the people and the king. People were happy because carrying paper currency was more convenient and the king was happy because it did away with the trouble of minting fresh coins to meet rising demand.
In case of gold coins, gold supply could be increased either by procuring more gold or by lowering the quantity of gold in existing coins and by using the extra gold for minting more coins.
Gold/Silver coins etc were a natural precursor to the use of paper currency, as the value printed on it would be easily convertible to the underlying precious metal.
The second practice of lowering the quantity of gold for minting more coins is called “debasement” and one can simply print more paper currency by reducing the pre fixed amount of gold repayable against each currency. This led to era of convertible currencies, where you can convert your paper currency at any time with a previously fixed amount of another commodity such as gold.
But as you keep on reducing the pre-fixed amount of gold payable against paper currency, you reach a point when the actual gold repayable is almost negligible. They you may wonder why you should bother about keeping a paper currency that can be physically converted into gold. But people wanted to use paper currency only as a medium of exchange for other goods and services and would not have minded losing gold if they were given an assurance that paper currency would not lose its status as a medium of exchange.
It was then decided to make paper currency compulsory for all to accept the paper currency as a medium of exchange. Paper currency became a legal tender, which means that you had the right to offer the paper currency as a settlement of your debts and others are bound to accept the same. This is what led to the birth of “fiat currency”.
Gold/Silver coins etc were a naturally precursor to the use of paper currency, as the value printed on it would be easily convertible to the underlying precious metal.
Fiat currencies are worth the paper securities backing them. To print “fiat currency” it is not compulsory to have the backing of gold, it can be printed simply on the backing of government securities. So the paper currency you hold loses physical convertibility with gold, however it retains financial convertibility with government securities backing it. So you can convert you money into government securities and vice versa. But many also criticize the era of fiat currency for the unbridled increase in money supply.
Recap: Why move from Barter to ‘Money’
The process of evolution of a commodity into a money is general and universal. It occurs anytime a large group of people, trade goods and services under the barter. This process can be broken down into simpler parts:
‘Selection pressure’, the force driving the natural selection process, is the problem of a double coincidence of wants.
‘Selectors’ are the intelligent decision makers trading goods and services via a process of indirect exchange.
The selectors, guided only by experience from past transactions, will select from among competing methods of payment, those commodities that can be most easily traded for other commodities and services.
An understanding of the fundamental concepts of money i.e. medium of exchange, measure of value, and store of value etc is not required at at for this process of selection to occur. The selectors are driven only by their desire to make life easier on themselves more than anything else.
Increased selection of one commodity as a method of payment will only increases its “Preferability” as a method of payment in the eyes of the selectors. This causes a positive feedback loop to occur, causing even more selectors to select this commodity as a method of payment.
The end result of this process is that over time, an entire population of people are now buying and selling their goods and services in exchange for that single commodity only. By definition, this commodity is money, whether the selectors are aware of it or not. When a commodity is used as money, the money is called “commodity money”. Among primitive tribes, everything from shells, to cattle, to cocoa beans have been used as commodity money. Gold and silver were used as commodity money right up to the beginning of the 20th century.
Price Shocks?
Fiscal measure?
Declining output?
Excess money supply?
Monetary tightening?
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