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.