Money makes the world go round (some say that it actually makes the world round – but they’re crazy), but what is it exactly and where did it come from? Money is something of value which can be traded for goods and services. You may be wondering what the difference is between goods and services. Goods are tangible – they can be seen and touched. Services on the other hand are provided by other people, usually with skill involved. Let’s say you drive to the gas station for some gas. While filling up, you walk into the store and buy a soda. The soda is a good – you can see it and touch it. You get back into your car and decide to leave, but your car won’t start. Now, you have to pay the mechanic at the gas station to fix your car. That is a service. You can’t see or touch the service, but you get utility out of it.
In this money lesson, we want you to realize that money hasn’t always been coins and paper, but rather, it has evolved through time. In ancient times, we’re talking cave man days, people used bartering for trade in place of money. Bartering is the exchange of resources, either goods or services. I have something you want and you have something I want. We are both happy with the exchange. Bartering is the oldest and longest lasting form of trade. Cave men did it 60,000 years ago, trading food for clothing and kids do it in the lunchroom today trading stuff like Oreos for Doritos. At some point you run into the situation where you have something I want but I don’t have anything that you want. Now what? We need a widely recognized and universally valued good for trade.
The first known attempt at this occurred in China between 9000 and 6000 BC. The good was livestock. People would trade cows, chickens, and goats for other goods and services. Having someone build a hut might cost 2 cows. A bag of rice may have cost 1 chicken. You can imagine the problem with this form of currency. It’s not exactly easy to carry a couple of cows around in your pocket.
It wasn’t until 1200 BC when cowrie shells came into circulation. Again this was in China. Cowrie shells are small shells that wash up on the beaches of Asia. The advantage of these shells was that they were easily transportable; however, there were issues. One problem with the shells was that they were fragile. Imagine going out to dinner and when the bill comes, you pull out your handful of shells only to realize that you sat on them during dinner and pulverized them. Now, you have to wash dishes in the kitchen. The other problem was that there was a relatively limited supply. If a thousand people in a village each had 1000 shells, that’s 1 million shells people had to find on the beach. Regarding cowrie shells, it’s likely that supply could not keep up with demand.
Metal finally came into the picture in 1000 BC. At this point it wasn’t coins, but metal objects, such as knives and axe heads that were traded. These weren’t great forms of currency themselves, but they did lead to the more modern form of currency. In 500 BC China introduced the use of metal blobs or slugs. The metal used was made from base metals, with no intrinsic value. Governments started to take an interest in currency and began officially recognizing its value by stamping the metal blobs with symbols to prove authenticity. Dynasties, kingdoms, and other forms of government had their own unique design.
Eventually, governments started pressing these metal blobs into the familiar coin shape we have today. At some point someone thought it would be a good idea to create coins from precious metals, such as silver and gold. Can you think of a reason why this may not have been a good idea? The problem with using coins with intrinsic value is that people would skim. Imagine I have a gold coin worth $10. I could scrape some of the gold off and keep the dust. I could then trade my $10 coin for $10 worth of goods and services or even for another $10 gold piece. I could shave some gold off this coin and continue to do this. Eventually, I would have been able to create $10 worth of gold from other gold coins. As you may have guessed, coins of precious metal became lighter and lighter. This is why you see in the movies sometimes people biting coins –they’re testing for its authenticity. If the coins were too thin or patched with softer metals, the coin would be more likely to bend or break.
We learned how metal coins came into being, but now let’s turn to the introduction of paper currency. China started producing paper currency in 806 AD. The first attempt at this did not go too well. The paper notes were not tied to anything of value, like gold. Also, the printing process was not very regulated. Because there was no accountability, notes were printed impunity. This resulted in an oversupply of paper notes, and this caused the value of the notes to fall dramatically. This is an example of inflation – when the supply of money surpasses the relative availability of goods.
In 1816 Britain borrowed the idea for paper currency from China, but instead of basing the paper on nothing, they based it on gold. This became known as the Gold Standard. If you had a paper note with $100 (or in England it would have been the pound), then you could turn the note in and demand $100 worth of gold. The denomination on the paper bank notes corresponded to the equivalent value in gold. This circumvented the problem of inflation because the amount of notes they could print was limited by the value of gold they had in the vaults.
In 1900 the U.S. thought the Gold Standard was a good idea and adopted it. This lasted until 1930 when the Great Depression hit. The U.S. government felt it would be a good idea to devalue the U.S. dollar, but they couldn’t do this as long as they were on the Gold Standard, since all money was tied to the value of gold held. As a result, the U.S. moved off the Gold Standard. Now, when money was printed, they didn’t have to hold themselves accountable to the gold; they could print however much they wanted. If they wanted to make the dollar worth less, they could just print more money. When the money created is not tied to anything of value, this is called FIAT currency. This is where we are today in the U.S. We are still using FIAT currency. Our dollar is no longer backed by gold, but rather it is now backed by the full faith and credit of the U.S. government.
Do you recall China’s problem with printing money, when their money wasn’t tied to anything of value? FIAT money runs the risk of inflation, especially when those in charge are irresponsible. The U.S. had high inflation in the late 70’s and early 80’s, but there is a more recent example of the world of hurt inflation can cause. In Zimbabwe, people of the country grew pessimistic regarding their currency, the Zimbabwe dollar. Rather than using the Zimbabwe dollar, they preferred to use currency from other countries, such as the U.S. dollar or Euro. The government recognized this and decided that it would legalize the use of some foreign currencies for transactions in Zimbabwe. This completely shook what little confidence the people of Zimbabwe had in their dollar. Zimbabwe just didn’t have inflation, they had hyperinflation, including that of 231 million% in July 2008 and then another 471 billion% in August 2008. It was said that a person would starve to death on 1 billion ZWD/day. The Zimbabwe government did what they could to deal with the inflation, including printing 100 trillion notes (that’s a 1 with 14 zeros after it! How does that even fit on a bill?!). Needless to say, the Reserve Bank of Zimbabwe recently decided to retire the currency. Any bank account balanced with 0-175 quadrillion will be able to exchange their Zimbabwe dollars for $5 U.S. The officially recognized currencies include the South African Rand, Botswana Pula, Pound Sterling, Indian Rupee, Euro, Chinese Yuan, and the United States dollar.
This is an example of survival of the fittest and the fact that currency continues to evolve. The future of currency may be electronic, such as cryptocurrencies, like Bitcoin. But, be very careful with these. They are a new frontier and there is no shortage of people with ill intent ready to prey on the unsuspecting. There have been numerous examples of people getting ripped off in cryptocurrency land. In fact there have been websites whose specific purpose was to steal bitcoins from unsuspecting customers Part of the attraction to villains is that there is little recourse. Most countries don’t recognize cryptocurrencies as legal tender. It may make sense to wait to see how electronic currencies play out before getting involved, or at the very least, be extremely cautious. In this money lesson, we want to reinforce the point that to be considered ‘real money’, it must store value, act as a portable currency, and be a unit of account. If your ‘money’ does not have all three, you may just have a ‘currency’.