A Brief History of Money
By James Burowiecki
IEEE Spectrum, June
Edited by Andy Ross
Economists typically define money by the three roles it plays in an economy,
as a store of value, as a unit of account, and as a medium of exchange. All
of these roles have to do with buying and selling.
In the seventh
century BCE, the small kingdom of Lydia, located between the Mediterranean
and the Mideast, introduced the first standardized metal coins. Coins became
ubiquitous throughout the Mediterranean. They facilitated the flow of trade
and established the authority of the state.
Money encouraged the
spread of markets. Once part of your economy is taken over by markets and
money, they tend to colonize the rest of the economy. Money makes market
transactions easier and using it redefines what people value. Governments
embraced hard currency because it let them collect taxes to build military
The rise of the Roman Empire led to an increase in the use of
money. It was used to unify and expand the empire, reduce the costs of
trade, and fund the armies. Several centuries later, the fall of the Roman
Empire led to a decline in the use of money. Cities shrank in size and
The rise of feudal society undercut money. The
basic relationship between master and vassal was mediated not by payment for
services rendered but rather by an oath of loyalty and a promise of support.
Land belonged to the king, who granted use of the land to his lords, who in
turn provided plots of land to their vassals. A feudal estate was often a
closed community in which money had little use.
Money is impersonal.
With it, you can cut a deal with a stranger. As long as your money and his
products are good, you two can do business. As long as you have sufficient
cash, all doors are open to you. These characteristics encourage trade and
the division of labor, reduce transaction costs, and make economies more
efficient and productive. These same qualities let money corrode traditional
By the 12th century CE, Europeans saw money as
something to invest in order to make more money. A banking industry emerged
in Italy. The banks introduced such financial products as municipal bonds
and insurance. They balanced credit and debt and invented the bill of
exchange, which was a document representing a quantity of gold for use by
traders and travelers.
In the 16th century in Europe, the amount of
money in the economy was still a function of how much gold and silver was
available. The rulers of Spain and Portugal plundered their New World
colonies to accumulate vast hoards of gold and silver, which triggered
inflation and tumult in the European economy.
Today in the United
States, the Federal Reserve can increase the money supply without looking
for gold or printing more dollars. Only about $1 trillion of the roughly $10
trillion money supply exists in the form of paper cash and coins. The Fed
buys government bonds and treasury bills from banks and then credits the
banks accordingly. As the banks lend, invest, and otherwise spend this new
money, the overall money supply increases. To decrease the money supply, the
Fed sells bonds to banks and then debits their accounts. The banks have less
money and the money supply shrinks.
The view of money as commodity
began to shift only with the widespread adoption of paper currency. In 1862,
Congress finally allowed the government to print paper money. Before then,
private banks were issuing bank notes, in theory backed by gold but with no
The Bank of England adopted the gold standard in
1821, promising to redeem its notes for gold upon request. As other
countries followed suit, the gold standard became the general rule for
developed economies. The gold standard brought price stability but
deflation. Economies falling into recession could not do anything to quickly
set things right, so they took a long time to recover from downturns. But
banks made loans freely against their gold reserves. The amount of paper
currency in circulation dwarfed the amount of gold and silver behind it.
The First World War finally derailed the gold standard. Governments
needed more money, so they just printed it. Currencies today are fiat
currencies, backed by the authority of the issuing government. Many people
say reliance on fiat money gives too much power to the government, which can
recklessly print as much money as it wants. Yet even with the gold standard,
governments revalued their currencies from time to time, in effect dictating
a new price for gold.
The notion that gold is somehow more real than
paper is a mirage. Gold is valuable because we say so. We can say the same
for colorful rectangles of paper. Instead of worrying about finding more
gold and silver, we can focus on managing the money supply. Central banks
have much more flexibility in dealing with economic downturns. Recessions
have been shorter and less painful since the gold standard was abandoned.
Critics of fiat money dread talk of central bankers tinkering with the
money supply. They believe it will lead to runaway inflation. We cling to
the belief that money needs to be backed by something solid. But when a bank
makes a loan, it simply credits the borrower's bank account, so with each
loan it adds incrementally to the money supply.
The recent crisis
should remind us of the dangers of runaway credit. But it's a mistake to
yearn for a more solid foundation for the monetary system. Money is a social
creation, just like language. What matters is not what it is, but what it
does. Successful currencies lubricate commerce and help people work and
The Future of Money
IEEE Special Report