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The literature on the origin of money traces the evolution of money in different parts of the world. It explains the transition from direct exchange (barter exchange) to indirect exchange and within the indirect exchange analyses how various commodities and non-commodities acquired the characteristics of money. The nature of money literature also looks at the qualities and the characteristics or functions of money and again the literature also discusses the issue of why money as an institution arises through the spontaneous-order process.
This essay reviews and explains these broad issues in the literature. Section II of the essay explains the origin and evolution of money in different parts of the world, while Section III discusses the nature of money in terms of qualities and functions of money. Section IV then explains why money is an institution that arises from the spontaneous-order process and Section V finally provides the summary and conclusions.
II.The Origin and Evolution of Money
The literature on money links the origin of money to the emergence of trade or exchange among individuals. In the early stages of trade, exchange involves direct exchange of goods or services for other goods or services. This direct exchange of goods or services is known as the barter system and it was more of individuals exchanging their surplus goods for a comparatively necessary goods or what Carl Menger calls economising individuals exchanging goods “that have a smaller use value to them than goods in the possession of other economising individuals who value the same goods in reverse fashion”1.With economic progress and specialisation in production resulting in an increase in trade it became increasingly clear that voluntary direct exchange would be impossible to make everyone better-off because of the inconveniences of the barter system. Major inconveniences under the barter system include double coincidence of wants, difficulties of sub-division, measure of value, store of value, portability and the inconvenience of borrowing and lending. Menger explains the concept of double coincidence of wants as a rare situation “that one person with a smaller use value of a good may meet another person who value the same good in the reverse fashion and be prepared to change”2. The barter economy also lacked common measure of value since there was no common base to measure the value of things. Moreover, the difficulty of carrying bulky goods from place to place did not enhance exchange under the barter system. Again, the lack of a common store of value under the barter system means individuals do not have proper means to store their wealth. These inconveniences of the barter system led to the development of a process of indirect exchange.
Indirect exchange involves the use of one of the goods in the community as a medium of indirect exchange, that is, to serve a monetary function. Menger explains the choice of the particular good in any community to become a medium of indirect exchange, through the concept of the good’s saleability at any given time and place relative to other goods under the influence of custom. Thus writes Menger, “With economic progress, therefore, we can everywhere observe the phenomenon of a certain number of goods, especially those that are most easily saleable at a given time and place, becoming under the powerful influence of custom, acceptable to everyone in trade, and thus capable of being given in exchange for any other commodity”3.
According to Menger, in the earliest of economic development, cattle seem to have been the most saleable commodity among most peoples of the ancient world. “Their marketability extended literally to all economising individuals ……………. and over a wider geographical area than most commodities”4. Thus Menger argues that as a result of its marketability, trade and commerce of ancient Greeks, Romans and the Germanic tribes were made in cattle. Menger further argues that rising civilisation, division of labour and the gradual formation of cities resulted in the simultaneous decline in the marketability of cattle and the increase in the marketability of many other commodities, especially the metals then in use. He states that “in all cultures in which cattle has previously had the character of money, cattle money was abandoned with the passage from a nomadic existence and simple agriculture to a more complex system in which handicraft was practiced, its place being taken by metals in use”5. According to Menger therefore, with the progress of civilisation, the precious metals became the most saleable commodities and the natural money of peoples in Europe. The three most saleable of the precious metals were copper, gold and silver. The first metallic money was measured by size and weight which therefore required weighing instruments. The introduction of coins enabled payment to be made by tale or count instead of weight.
The evolution of money moved from metallic money with the introduction of paper receipts against deposit of gold deposits and bullion and again with the introduction of bank notes with promises to pay gold or silver on demand. These paper receipts entitle anybody to take actual delivery of the commodity-type money and were initially backed one-for-one with the commodity-type money and according to McCulloch “closely resemble the gold certificates and silver certificates once issued by the U. S. government as money”6. McCulloch further argues that, issuers of money certificates later found out that they can only keep fractional reserves of the monetary commodity because only a fraction of the people who acquire money certificates will actually want to redeem them. “It follows that in practice, issuers of money certificates will ordinarily find they can get away with keeping only a fractional reserves of the monetary commodity”7. The inconvertible fiat money therefore evolved through a long historical process from a prior commodity money. The introduction of fiduciary issues eventually led to the development of fiat money. However the general use of fiat money depends on its acceptance by the public. Thus states McCulloch “Government action has profoundly modified this evolution at times, often in unintended ways. But still the government is incapable of endowing fiat money with value out of thin air”8.
III.The Nature of Money
Though the concept of money is not amenable to a single definition, there is consensus among economists about the essential characteristics or qualities of money and these include general acceptability, portability, durability, cognisability, homogeneity, divisibility, stability and scarcity. Most commodity moneys did not possess all the characteristics or qualities of money and contributed to their loss of marketability as civilisation progressed over the years and hence to their loss of being money. Modern money in terms of representative tokens, however, possesses all the characteristics or qualities listed above.
The functions of money have been extensively investigated in the literature. McCulloch argues that “money ordinarily serves as the economy’s customary unit of account, as a standard of deferred payment, and as a store of value in addition to its function as a medium of exchange”9. He further argues that only the medium of exchange function is however essential because once the economy settles on the common medium of exchange, goods would automatically have their values computed in terms of the monetary good. To McCulloch, money serves as a store of value from the instant it is received to the time it is spent. Again, he further argues that, provided the future purchasing power of money is relatively predictable, contracts in loans could be written in terms of monetary units and to serve as the standards for deferred payment. McCulloch thus concludes, “The unit of account, standard of deferred payment and store of value functions of money are only secondary functions. The only really indispensable role of money in the economy is its role as medium of indirect exchange”10.
IV.Money as an Institution that arises from the Spontaneous-order Process
The thesis of money as an institution that arises from the spontaneous-order process originates from the Austrian view of institutions. An important aspect of the spontaneous order concept is that it is unplanned, that is, the unintended consequences of individual actions. The concept of spontaneous order thus provides a framework for seeing that social institutions are not products of human design but are products of human action. Within this spontaneous order framework money is seen as an institution arising out of human action and not out of human design. Menger, based on this Austrian tradition, therefore argues that money is a natural product of human action. “As each economising individual becomes increasingly more aware of his economic interest, he is led by this interest, without any agreement, without regard to legislative compulsion and even without regard to public interest, to give his commodities in exchange for other more saleable commodities even if he does not need them for any immediate consumption purposes”11. According to Menger the origin of money is entirely natural with legislative influences of the rarest instances and that certain commodities came to be money quite naturally, as the result of economic relationships that were independent of the power of the state. Menger finally concludes that “money is not the product of an agreement on the part of economising men or the product of legislative acts. No one invented it”12.
V.Summary and Conclusions
The origin of money is traced back to the early stages of trade, where initially direct exchange of goods or services for other goods or services (the barter system) formed the basis of trade. The inconveniences of the barter system provided the basis for the development of a process of indirect exchange. Indirect exchange involves the use of one of the goods in the community as a medium of indirect exchange, that is, to serve a monetary function. The choice of a particular good is based on the concept of saleability or marketability of the good. Thus from ancient times to modern times and in different parts of the world the most saleable good becomes the medium of indirect exchange.
There is consensus among economists about the essential characteristics or qualities of money and these include general acceptability, portability, cognisability, homogeneity, divisibility, stability and scarcity. The functions of money are also explained in the essay with the conclusion that the function as medium of exchange is the core function of money. The other functions of measure of money, store of value and standard of deferred payments are basically derived from the core function of medium of exchange
The thesis of money as an institution that arises from the spontaneous-order process is explained from the Austrian view of institutions evolving from human action rather than from human creation or human design. According to this view spontaneous order emerges from individual actions to achieve multiple ends using abstract rules.
The concept of saleability of goods used by Menger as the basis for indirect exchange is logical and plausible and is an explanation agreeable to, by most economists and myself. The thesis of money as an institution that arises through the spontaneous-order process is very insightful to me. However, I believe that money as an institution emerges neither from solely through the spontaneous-order process nor solely by human design. For me, money as an institution emerges from a combination of both human action and human design.
Menger, Carl, “Theory of Money”, in Readings in Money and Banking, editor; George Selgin; Pearson Custom Publishing, 3rd edition; pp 12
See note 1: pp 12-13
See note 1: pp 14
See note 1: pp 16
See note 1: pp 17
McCulloch, J. Huston, “Why Bother ?” in Readings in Money and Banking, editor, George Selgin; Pearson Custom Publishing, 3rd edition: pp 8
See note 6: pp 8
See note 6: pp 9
See note 6: pp 9
See note 6: pp 11
See note 1: pp 14
See note 1: pp 15
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