The Five Stages in Which The Money Evolved
- Economic goods Goods that had an intrinsic value were used as the medium of exchange, i.e., the money substance. The commodity chosen as the money substance was considered to have inherent value, but by a curious twist of fate, the very fact that the commodity was so selected made it scarcer and the value of it rose as the demand for it increased. Money, in the form of economic goods, first evolved in China thousands of years ago when bill hooks, chisels, cloth, knives, shirts, and spades were used to purchase land and other things of value. The whole business was so cumbersome that in about 1200 BC the Chinese ruling authorities had small 'models' of shirts, knives, and other articles made to facilitate exchange. The model's shirts were called up and model knives were called to. These tokens were still bulky and, therefore, not very portable or transferable, besides being difficult to count. In the end, the tao was reduced merely to the metal top with a hole in it: the tao was round so that it could roll and flat so that it could be piled (circulation and saving are still fundamental uses of money). Tao money was called 'cash' and was still in use in China in the twentieth century.
- Metals Metals became the commodity most commonly used as money because the metals were scarce, durable, and divisible. Many metals have been used as money, e.g., iron, copper, gold, silver, nickel, etc. Some metals have been found too cumbersome, e.g., iron, while other metals have been found too rare and valuable, e.g., platinum. There are also the problems of weighing and assaying metals. Gold became the most valuable metal to be used as a money media and it had important economic effects in the nineteenth and twentieth centuries because of the part it played in the various gold standards and international liquidity. Today, gold is too valuable to use for normal domestic currency. Gold coins (sovereigns and half sovereigns) have rarely been used in the UK since 1914, and since 1931 (because of their great scarcity), they have been worth more than their face value.
- Coins The inconvenience of ascertaining the correct weight and quality of gold and other metals led to the development of coinage. The coin was marked with its value by reference to an accepted unit of account (50p = 50 percent of the value of the unit), and also embossed with the head of the Chief of State, be it monarch or president. The State thus gave official backing to the coins and the necessity of weighing and assaying was obviated. The early history of coinage is riddled with stories of forgeries and debasement so it often took centuries before coins were accepted as genuine money. Money that is officially authorized by the State is known as fiat money. The first form of fiat money was coinage. However, apart from the clipping of coins, and the minting of coins by so many sources that it was impossible to keep a check on legality, the State itself was not averse to debasing its coinage. Henry VIII debased the English coinage to such an extent that in about eight years the amount of silver in so-called 'silver coins' was reduced by one-seventh. Sir Thomas Gresham, the monetary adviser to Elizabeth I, realized the dangers to the economy and is purported to have coined the maxim (often quoted as Gresham's Law) that: 'Bad money drives out good." This law holds in most circumstances even today. The student will admit that if a forged coin is passed to him, he will attempt to pass it on quickly. Good coins will, therefore, be driven out of circulation, but the bad coins will remain.
- Banknotes The earliest forms of banknotes were backed by valuable metals such as silver or gold. These notes were issued by private banks, sometimes called country banks. The progenitor of the banker was the medieval goldsmith. He was probably the only person in the vicinity possessing a safe, and it became customary for people to deposit their gold and other valuables with the goldsmith for safekeeping. In return, the goldsmith would issue a Goldsmith's Receipt. If Mr. Samuel Pepys wished to pay Mr. John Evelyn the sum of £50 to settle an outstanding debt, instead of withdrawing the gold from the goldsmith's safe and handing it to Mr. Evelyn (for the latter, perhaps, to return to the goldsmith for safekeeping), it became the practice for Mr. Pepys to write a note on the back of the receipt, i.e... an endorsement, authorizing the goldsmith to transfer the ownership of the gold to Mr. Evelyn. It was but a short step from this convenient arrangement to the issue of goldsmith's receipts for 'round sums' (say, 10 receipts of £5), that could be used as a type of banknote. These banknotes became a form of money although in the beginning their acceptance was limited to a particular area. In the early nineteenth century, the people of Norwich preferred to accept a note issued by Gurney's Bank (now part of Barclay's), rather than a Bank of England note. One of the main principles underlying the Bank Charter Act of 1844 was that the right of note issue should be transferred from the private banks to the central bank. The Bank of England was legally compelled to retain gold holdings in its vaults to the total of its note issue, apart from a relatively small fiduciary (from the Latin 'Fiducia', meaning trust) issue of £14 million. Joint stock banks had never had the legal power to issue notes and as these banks, nowadays more commonly referred to as commercial or clearing banks, became the principal institutions of private banking, from 1844 the right of note issue was almost entirely in the hands of the Bank of England. Private banks that had been issuing notes were allowed to continue unless they became joint stocked or otherwise disappeared from the banking scene, but two-thirds of their note-issue rights passed to the Bank of England.
- Paper money It may appear at first sight that there is little distinction between the evolution of banknotes and paper money, and, indeed, the evolution of money is not distinguished by distinct stages, but rather one stage merges into another. There is no universal chronological order in the evolutionary stages of money; commodities such as cigarettes have been accepted as money in some parts of Europe even in the last 30 years, alongside sophisticated forms of bank transference. It would be no illogicality to conceive of bank money and paper money as synonymous. However, in this context, we shall use 'bank money for notes backed by gold or some other valuable commodity, and paper money for money that is not backed. Since 1931 in the UK, paper money has been the main form of note issue in the sense that the notes are not convertible into anything of real value. The Government controls the quantity of money that is issued. No longer is the Government rigidly limited to the issue of notes and coins. The main advantage is that the Government can issue notes following the state of trade, but a serious disadvantage is that the fiduciary issue is an arbitrary amount, and governments have escaped from their indebtedness by dangerous inflationary increases in the money supply. We shall see later that the debate over the control of the money supply is the most controversial monetary question of the second half of this century.
The Attributes of A Money Substance
The origin and evolution of money are inexorably bound up with the abilities or criteria that a money substance must possess so that it can fulfil its functions successfully. There are 11 main criteria:
- Acceptability Anything will serve as money so long as it is generally acceptable. This is the most important reason for choosing anything as money. Almost worthless papers, or plastic coins, can act as money, so long as people accept them. Our coins are token coins, rather than standard coins, and not worth their face value.
- Durability money must last for a reasonable length of time and not be easily lost. A criticism of the IP coin issued in 1971 has been that it is so small that it is frequently lost. On the other hand, the 10-shilling note, used before the introduction of the 50p coin, only had a lifespan of about three to five months. A 50p coin may well last for 50 years.
- Portability Money should be easy to carry whether in a pocket, purse, or wallet. Transactional, precautionary, and speculative uses of money are facilitated when it is conveniently handled.
- Transferability Some students find it difficult to distinguish any real difference between portability and transferability. Cannot money that is easily carried be transferred? Perhaps the distinction is best illustrated by the example of the South Sea island where huge rocks are used as a form of money; on each rock is inscribed a person's name. The person does not own the useless rock-it is merely a form of deed or entitlement to land or other property on the island. When the ownership of the land is changed then the new owner's name is inscribed on the rock, and the previous owner's name is erased. It is a form of money that has worked successfully for a very small community up to the present day. This form of money gives transferability without portability, but would hardly be satisfactory in a complex society. Our notes and coins facilitate the flow of money by utilizing easy transferability.
- Homogeneity Although one may hesitate about accepting a tattered pound note, to all intents and purposes one pound note is of the same value as another. When cattle are used as money, they have the disadvantage of not being homogeneous in either size or quality. Although no standard pound note exists to which other pound notes may be compared (as is the case with the pound weight or the yard length) if money is to perform its functions properly there must be a 'standard' so that all notes and coins of a similar value may be instantly accepted.
- Cognizability Homogeneity is closely allied with recognizability, i.e., each note or coin should be easily recognized for what it is; otherwise, monetary values would go haywire and much time would be wasted in attempting to determine the value of the particular unit of money. The manufacture of plastic coins has been considered, if only because they would be very cheap to produce. Normally, they could also be easily cognizable if made of different colours, but blind people would be placed at a considerable disadvantage. Much trouble is taken to make notes and coins distinctive in appearance.
- Divisibility There must be no loss of exchange value merely by dividing the main unit of account into smaller parts for the sake of convenient use of minor transactions. Thus a pound note or coin valued at 100p may be divided into coins of 50p, 10p, 5p, 1p, and p. Two 50p coins have purchasing power parity with a pound note or a pound coin.
- Multiplicity Divisibility of the money substance makes for small and exact payments, but it would be time-wasting to have to count out 100-pound notes, to pay a debt of £100. Assuming that the cheque system is not being utilized, it would be preferable to pay the debt with two £50 notes. In British history, there has been a greater multiplicity of the main unit of account than prevails today; before the cheque system became commonplace, the Bank of England issued notes of 1000 denominations.
- Stability Stability of money values was more easily obtainable when standard coins, which were worth as much as metals as they were as coins, were in general use, e.g., in Britain until 1914. As the annual production of the metal is small compared with the existing stock, the stability of metal for coins is enhanced compared to other money substances. Fixity of value is difficult to obtain over the long period but for short-term transactions, money must have a stable value. If money loses stability of value for everyday purposes, then it ceases to be acceptable, as in Germany in 1923, and we have learned that acceptability is the main criterion of any form of money.
- Liquidity It is controversial whether liquidity, in the sense that it must be possible to exchange money for any other asset, is an attribute or function of money. In some ways, it may be held to be both. We merely note here that whatever is used as a money substance must be able to flow or facilitate the circulation of goods.
- Legality Money has not always been legalized and backed by the State. Indeed, we began by contending that anything could be used as money if it found general acceptability among users. However, in modern times, it is a general rule that people will not accept any form of money unless it is authorized and, therefore, given legality by the State.