The Story of Money Part 2

            As promised, I am back with a sequel to the last piece about the story of money.  I mentioned that the main features of money are durability, divisibility, and wide acceptance as having value.  I also mentioned that these have not always been the case and that there is at least one notable exception that comes to mind, in the area of divisibility.  But this story in turn will take us to the more valuable insight about the nature of money in modern times, the concept of fiat money.    

"I'll need some help with getting this to the grocery store."

              There is an island in the South Pacific called Yap which until recent times has used large round blocks of stone as their currency, called Rai.  The origin of this money is unknown but essentially the scarcity of these stones (quarried and milled on another island), the difficulty associated with transportation (20+ men were required to move the largest ones), and the propensity for the movers to die with stones in tow when storms struck on the open sea made them sufficiently valuable to use as currency.

              While not all stone money items were gargantuan, it does not take much imagination to realize that having stone money of any size is not conducive to easy commerce between citizens.  This is where the story becomes even more interesting.  Once people realized that moving the Rai around was not practical, they started writing promissory notes that entitled the bearer to a particular stone stored in some location on the island.  Tangentially, the parallel between this kind of money and gold or silver certificates is easily seen.  This allowed easy transactions between people since a stone could be retrieved by anyone bearing the certificate.  Theft was out of the question because of the level of trust on the island and the fact that stealing boulders is no mean feat.

               On one fateful voyage, a very large and accordingly valuable stone was lost to the sea.  But as the inhabitants had grown accustomed to dealing in paper that represented stones, and the representative paper was still in existence, the populace agreed that the stone was out there somewhere and that its document was still valid money.  Thus fiat money was born for the island of Yap.

                “Fiat” is the Latin word for “it shall be” or “let it be done” and fiat money is money whose value is not derived from an underlying asset like gold, silver, or stone.  Rather its legitimacy comes entirely from the faith of the people who use it and, more often that not, the government that decrees it as the legitimate currency of the land.

                In modern times, the rise of Bitcoins has been an endlessly fascinating form of currency because it is backed by no government at all.  I recommend reading up on it because it is much too involved to deal with sufficiently here.  Yet even though there is no ruling authority that mandates it as having value, the faith and trust of those who deal in it online has elevated it to the status of money that is widely accepted in many stores (mostly online) across the globe.  But what makes it even more spectacular is the fact that it does not even have a physical presence.  In truth, it is the most fiat of money of all. 

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The Story of Money

What is money and why do we need it?  How did it come about in the first place?  This is a question that I addressed in conversation recently with a friend after visiting the Hong Kong Monetary Authority, its equivalent of the Federal Reserve.

Everyone knows intuitively what money is: a medium of exchange and permanent store of value.  In other words, one person has coins and bills and another person has coffee beans, guitars, or microscopes.  They trade one for the other and everyone goes on his way.  The permanence of money is also an important characteristic.  It would not do to have currency that decays over the course of time!

Where did money come from and why do people use it rather than just bartering like our ancestors used to, and why do we use paper or metal which have no intrinsic value rather than something that does have value?

The need for money is shown in the following story, as related to our class by my first economics professor.  Imagine that you are a maker of guitars and that you want to get coffee.  So you take your guitar to a coffee farmer and try to work out an agreement on a trade.  The problem arises: what if the coffee farmer does not want a guitar?  Or what if he does not have enough beans on hand to pay you for that guitar?  In modern terms, for example, 45.4 pounds of Starbucks coffee costs the same as a Fender Stratocaster, (if our ancestors had the benefit of price shopping on Amazon.com)! The problem with a pure bartering system is that not everyone wants what you have or perhaps they do but cannot accommodate your requirements for the trade. 

This is where money comes in: a society agrees on something that will be used to facilitate exchange whether it is coins, stones, shells, salt, metal ingots, or any number of other items used by civilizations in the past.  Besides society-wide acceptance of their value, money possesses at least one other advantage over trading goods for goods: it is easily divisible.  You will notice that half of a guitar, a third of a cart, and the base of a microscope are no good to anyone.  In other words, if our farmer from above didn’t have 45.4 pounds of coffee on hand, the trade would not go through.  But with money, the trade can happen between anyone who has money and anyone who is selling something. To recap, these features can be seen in money all over the world: easy divisibility, society-wide or universal acceptance in a country, and usually permanence in the material used to make it.  There are few exceptions but one or two of the most prominent ones deserve to be the subject of the next post. 

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China Seminar Post 3: The Real Wealth of Nations

            During one of our several university visits the lecturing professor gave us a particularly unique and memorable talk.  The typical speech we’d receive in these lectures tended to involve an economic lesson about some area that was growing such as how the city was planning to develop their infrastructure in this or that industry, or how 300 million people had migrated from rural areas to the cities, or how income has risen dramatically in the past several decades since the late 1970s.  This one, in particular, took a much more philosophical slant. 

            Professor Zhang Yu from Shanghai University spoke to us his philosophy about the reason that a country develops or does not develop.  Having grown up and been educated in an overtly Communist state, he learned that there was strength in unity of thought and belief.  He learned that the government was the benevolent institution to pass down those thoughts and beliefs for the good of the people.  But as he grew older and began to read independently (philosophers like David Hume), he came to a different conclusion.  He began to realize, as he told us, that the government cannot be the entity to oversee all aspects of life.  He told us that if the government controls thought and belief, then creativity and dynamism of the populace will be squelched, and a nation will be cursed with an inability to move forward.  As he said progress cannot be legislated, so he said that the power to transform a nation lies in the minds of its people.  Free thought emanating from the minds of free people is how society can evolve and change for the better.  So this brought him to his terminal point.  These days, those in governance over China’s cities and provinces put so much emphasis on how much is being exported, or how big the country’s GDP is from year to year.  This results in a measure of success being confused for success itself.  In reality, however, the true wealth of a nation is its people.  That country is rich which is blessed with free thinkers, tinkerers, and an environment conducive to the germination and sharing of ideas. 

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