Money is a medium of exchange that is accepted in a transaction. Money acts as a medium of exchange, can be used to settle debts and is considered as an account unit and as a store of value. Anything that has these features can be referred to as money but generally, money is anything that is accepted as a medium of exchange. Since the beginning of time, man has found ways of gaining things that he does not have by trading it for something of equal importance. Early forms of trade were facilitated through the exchange of goods for other goods. Over the years, different items have been used to secure payment for a good or service. These commodities include: shells, precious metals such as gold and silver, beads, ivory, salt etc.
The history of money started from non-monetary exchange or the barter system, which later developed into commodity economies which used commodity money. As markets developed, money evolved to metallic money, fiat money and most recently, electronic money. The study of the history of money and all its varied forms is called Numismatics.
The exchange of goods for goods without the use of money is known as barter trade. There is no evidence of a society which used barter as the primary means of exchange. It is however believed that barter trade mainly occurred between strangers or societies which were potential enemies.
Barter trade had numerous disadvantages the main one being the need for a double coincidence of wants. For example, if I had some wheat and wanted to change it for a pound of meat, it would be difficult for me to find a person who has a pound of meat and wanted some wheat. Another disadvantage is the indivisibility of goods such as animals. One would find it hard to divide a cow in order for it to fit a can of beans. Barter was also not a preferred method to be used as a store of wealth as agricultural goods were highly perishable. Barter trade has however been used in modern day economies between corporations and through the internet. Due to the numerous disadvantages, there was a need to adopt a new system for the exchange of goods. Barter gradually evolved into commodity currency after a good was preferred by individuals for use as a common currency.
Another form of non-monetary means of exchange was seen in the gift economies. Non-monetary means of exchange occurs where there is no common commodity which is regarded as having value and which can be generally accepted in the transfer of goods. The main non-monetary means of trade were gift economies and economies which operated through debt. Gift economies are economies in which gifts are given without any explicit agreement for immediate or future benefit. For these economies to exist, the practice of giving gifts had to be done by all parties involved. Such economies existed in the Trobriand Islands (known today as the Kiriwina Islands). They used Kula exchange rings which were passed or given as gifts and it was prohibited for an individual to accept a ring without giving back his/her gift. A person gave a gift as a sign of friendship or unity towards the recipient and the more a person received, the higher his or her social status was. Gifts were to be passed on as one was not supposed to hold on to a gift. Through this, exchange of goods in form of gifts was enabled and it created a form of non-monetary means of exchange. Gift economies, however, dwindled with the emergence of market economies. Debt also existed as a non-monetary means of exchange. In his book 'Debt: the first 5000 years', anthropologist David Graeber argues that debt was used as a means of exchange long before the advent of coins. People would buy goods at a debt and pay at a later date. If payment was not made, the debt was passed on to the person’s family.
These are economies which used money as a means of exchange for services and goods. There is no evidence to suggest that money was formed to replace barter. It is believed that money as a medium of exchange was not conceived by any individual but was gradually developed over time to facilitate trade. Historical evidence of past monetary economies is the Mesopotamian civilization and the Babylonians whose economies were based on currency. In Mesopotamia at around 3000 BC, the shekel was the unit of currency. It defined a specific weight of barley which was equivalent to materials such as bronze, copper and silver.
Commodity money is an item or commodity of value which is accepted as a medium of exchange. Commodity money has been used in past economies for the exchange of goods and services. Such commodities are gold, silver, copper, grain, stones, salt and other items. Commodity money is similar to barter; the only difference is that a single recognized commodity unit is accepted as a medium of exchange. Items such as wampum, tobacco, maize, beaver pelts and iron nails were used in pre-Revolutionary America while cowry shells were used in Ancient China, Africa and India. A specific weight of barley known as shekel was considered to be equivalent to certain amounts of silver and was used as the unit of exchange in Mesopotamia. In postwar Germany, cigarettes were used as a form of currency in some areas. Where the commodity money was metal, the government would put a mark to guarantee that the weight and purity of the metal were verified.
The government often charged a fee for this service. The difference between this mark and modern minted coins is that the commodity money would still be accepted even if they were defaced or altered. The commodity money would also have a higher value than the face value if they were melted and sold out. The first form of commodity currency in China was cowry shells which were used around 12000BC. Use of commodity money was also seen in Swaziland where red ochre was used as currency. Where precious metals such as gold and silver were unavailable, commodities such as ivory, salt, jewel and cowry shells were used (Cheal, 1988). Commodity money has helped to solve the main problem of barter which is the need for double coincidence of wants. If I want to trade a gallon of milk for a pound of meat, it would be difficult for me to find a person willing to trade with me. However, if I sold the gallon for gold coin, an individual having the pound of meat would be willing to trade the meat for my gold coin.
The emergence of commodity money enabled goods to be more liquid. Commodity money usually occurs where barter trade is common. Certain goods are seen to have monetary properties and are preferred in trade. This leads to the adoption of these goods as commodity money. In the early times of the British colony of New Wales, rum was preferred by many and accepted as commodity money replacing barter as the main means of exchange. Salt was also used as commodity money. From 500BC, people used salt and spices to pay wages and salaries. The discovery of steel and precious metals such as gold led to the development of coinage. The touchstone, a stone used to identify precious metals, helped individuals to determine the value behind a lump of metal. It enabled one to find out the amount of gold in an alloy.
Due to the general acceptance of gold as a medium of exchange, there was need to pre-determine the weight and value of a piece of metal before it was used as currency. This led to the development of the coinage system. The value of gold would be predetermined and a mark would be put on it to show its value. The use of commodity currency had its challenges. Coins were clipped or melted to be sold as precious metals as the coins had a higher value when melted than their actual face value. Another disadvantage was that pure gold and silver degenerated at high rates.
In Europe, during the 1670s and 1680s, the English gold coin began to rise against the English based crowns asmany Spanish and English traders had more interest in gold coins than silver coins. This created unease and instability in the value of the coins. Due to this instability, banks offered to change the coins for gold. In the 1890s, banks offered notes for the storage of gold and silver. Through this practice, a form of representative money emerged. As the paper receipts could be converted to commodity money stored in the banks, depositors would use the receipts to purchase goods, pay debts and as a store of wealth.
Trade Bills of Exchange
A bill of exchange gives a promise to make payments for goods or services at a specified future date. They became prevalent towards the end of the middle ages. With the expansion of European trade, Italian wholesale in wine, cloth, tin and other commodities relied heavily on credit. A bill of exchange was given in exchange for goods supplied on credit. The buyer had to have a good reputation and be endorsed by a creditor before the seller could participate in the trade. The seller could sell the bill of exchange to a merchant banker at a discounted rate. The bill of exchange was safer than carrying gold coin. Due to the acceptability of the bill of exchange in banks, sellers started using them to purchase goods. Bills of exchange were also used by traders to settle debts. This has resulted into a new form of money as bills of exchange also acted as a store of value.
In Egypt, another form of bill of exchange was used by the Egyptian grain banks. In the last quarter of the18th Century and early 19th Century, bills of exchange were used and accepted as a means of exchange before other forms of banknotes and checks were made available. An early form of the bill of exchange was developed in the English Monarchy in the 12th Century. It was referred to as the tally stick. The use of tallies runs until the early 19th Century. A tally was made of wood as paper was hard to arrive by in the 12th Century. The piece of wood was notched, with each notch representing the amount of tax payable to the crown. Tallies were also made in pairs. One piece was held by the treasury representing the amounts to be collected in future while the other piece was held by the assessors, representing the amount of tax owed to the crown.
The tallies gradually developed as a means of exchange for goods, services, gold and silver. The treasury could sell the tallies to middle or merchants and the merchants could collect the amounts in tax for themselves. The treasury could also use the tallies to settle debts owed to them and the recipients could then collect the tax or use the tallies to pay their own tax. The tallies were accepted as a means of exchange and were seen as a form of money. With time, the treasury started creating tallies which were not necessarily backed by any tax owed to them. The tallies were backed by the confidence that the public had in the treasury and were still used to settle debt and carry out transactions.
Goldsmith Bankers Financial intermediaries date back to the late 17th Century where scriveners’ kept gold deposits for the purpose of relending them. The Royal Mint stored huge hoards of gold deposits entrusted to it by traders and merchants. This changed however after King Charles took the gold as a fared loan (Isaac, 1979). Merchants and traders therefore, shied away from the Royal Mint and preferred to keep their gold in the vaults of private goldsmiths in London at a fee. The goldsmith would issue a receipt to prove that gold deposit was entrusted to him by the depositor. These receipts were restricted and could not be transferred to any other party as it was only the depositor who was entitled to use the receipt for withdrawal. As time passed by, goldsmiths started providing banking services. They started lending out the gold held in trust and in return, they would get income from interest earned. This change was highly profitable and the goldsmiths started paying interests for deposits in order to attract more depositors and increase the amounts they could lend out. This changed promptly the use of promissory notes to signify that the depositor owed the goldsmith some gold. The promissory notes were less restrictive and the holders could receive their gold on demand. This enabled the promissory note to develop into an assignable instrument as it was backed by gold which was accessible on demand. Increased trust and confidence in the goldsmith by the public enabled the promissory note to develop into a medium of exchange. The goldsmith could now lend amounts through promissory notes or using gold deposits. Through the activities of the goldsmith, a new form of money was created in the promissory note. The notes were used by the public to trade for goods, for the settlement of debts and as a store of value.
To promote trade, early merchant banks were developed. Their principal role was receiving of deposits and issuing of loans to individuals. Demand deposits are funds which are stored in accounts and can be accessed at the depositors wish. Merchant banks created bank notes which were backed by gold or silver deposits and partially backed by public confidence in the banking institutions. Through these bank notes, a new form of currency was created which enabled people to change them for goods or for services. The issuance of paper money can therefore be said to have been started by the commercial banks. After the success of the goldsmith bankers, merchant banks produced papers known as banknotes. The banknote was proof of deposit and individuals holding the banknote could access the deposited amounts on demand. The banknotes circulated widely and were generally accepted as a means of exchange. This practice continued in England till 1694.
In America, the issue of banknotes continued till the 19 Century while in Scotland, Scottish banks continued issuing banknotes till 1850. The larger and more creditworthy a bank was, the more widely accepted its banknotes were. In small banks, banknotes were accepted locally and at a discounted rate in wider areas. The banknotes could be converted to gold or silver by application at the bank. Over time, banks issued more banknotes than the actual deposits it had. This led to a huge loss of public confidence in the currency. Consequently, banks suffered bankruptcy as they could not pay the gold or silver that was demanded by holders of the bank notes.
The issuance of banknotes as legal tender was then taken up by the government. After 1694, the Bank of England was given the right to issue banknotes while in the USA the Federal Reserve Bank was given this right on its establishment in 1913. These banknotes were partially backed by gold and silver and until recently, they were forms of authorized currency. In the 19th Century, the British pound was the strongest and most stable currency and was considered to be equivalent to gold. This, however, could not be the case as the gold in the British treasury could not be able to convert all currency in circulation to gold. In 1970, the United States government gold stocks were equivalent to only 0.5% of its currency and banknotes, down from a value of 16% in 1880. This is different from period of 1880 and 1913 when a core of leading nations agreed to adhere to a fixed gold price. The gold standard, seen as a system to redeem all notes for gold was only prevalent for a small period of time. The gold standard was also used between nations to settle debt. However, after WW1, Britain and other leading nations abandoned it, and any attempts to revive it later proved futile.
In 1785, the US adopted a silver standard where the value of the US dollar was equivalent to a certain value of silver despite the fact that there was not enough silver to back all currency even at inception. The use of gold backed bank notes decreased due to the inability of governments to hold enough money to convert all its currency and pay its debts. There was a need therefore, to form a currency which was not backed by gold or silver.
This refers to money that has no backing in terms of reserves or commodities. It is the common currency used in most economies today. The United States switched to fiat money in 1971 abandoning gold backed notes. Governments print notes and mint coins to be used as legal tender in carrying out transactions. As the notes have no backing, the value of currency in circulation should be equivalent to the level of economic growth in a country. If the value in circulation is above the level of economic growth it results in inflation in the economy. Conversely, if the value of currency in circulation is below the level of economic growth in a country, it leads to deflation (Mauss, 1967). Fiat money is backed by the confidence that the public has in the government institutions. If the public loses confidence over the local currency due to inflation, the public shifts to a more stable currency. This situation was seen in Zimbabwe in 2008 where high levels of inflation led to the use of the US dollar for trading.
The increase in the level of technology over the past few decades coupled by the great strides taken in the banking industry, electronic money has been developed. Today, credit cards and debit cards are used in transactions. In countries such as Kenya, mobile banking has become a trusted means of not only transferring money, but of paying for goods, settling debts and as a store of value.