Evolution of Money

Ever heard the saying "Money makes the world go round"? Well, that seems to be the case throughout human history, as money has played a pivotal role in the development of human civilization and economies. The evolution of money has brought us to where we are today. Money can be in the forms of paper money and coins and also in intangible forms such as digital money.

But how did we get here? What really is money, and what are its functions and characteristics? What were the different forms of money throughout human history? These are all questions that come to mind when trying to understand the evolution of money. Get ready to learn more about one of your, my, and possibly, everyone else's favorite, money, but in particular, the evolution of money.

The Evolution of Money Meaning

Money is a medium of exchange that facilitates transactions. It also acts as a store of value and a unit of measure. The evolution of money is a series of development in the form of the acceptable medium of exchange throughout history. But why is money so important?

Money is important because it allows us to obtain the things we need and want. It is a crucial element for individuals in an economy as it is the gateway for individuals to attain utility - receiving satisfaction from the consumption of goods and services. Money is an agreed-upon form of payment that is used for the purchase and sale of goods and services and can also be used for lending and repayment of loans.

You are familiar with the paper money that we use in everyday life today, but money has not always existed in this form. There have been different forms of money throughout human history that played the role of facilitating economic transactions. This is what we mean by the evolution of money.

The Evolution of Functions and Characteristics of Money

Before we discuss how money evolved, let's take a look at the functions and characteristics of money for a better understanding of money.

Functions of Money

Money has three main functions.

Medium of exchange

Money functions as a medium of exchange by facilitating transactions between buyers and sellers. In order for money to be considered a medium of exchange, it needs to be widely accepted in the economy for the purchases of goods and services.

Store of value

Money holds its value in comparison to other commodities. For example, if you earned a hundred dollars in wages today, you will be able to use those one hundred dollars in the coming days or weeks, whereas if you earned a loaf of bread and some fruit in wages, they have a restricted shelf life. Money is definitely not perfect in storing value, as inflation would impact the purchasing power of money. However, it is an efficient and sufficient store of value for its intended use.

Unit of account

Money serves as a common tool for measure for economic transactions. Try to imagine that if you go to one store to buy a pair of shoes that are listed for 40 bushels of corn, and if you go to another store, the same shoes are listed for 25 apples. Having the shoes listed in two different forms of payment makes it difficult to determine the true value of the item.

Characteristics of Money

Money has various characteristics associated with it, which have made it widely acceptable.

Durability

Money should be durable as it is required for constant use.

Portability

Money should be easy to transfer from one place to another.

Divisibility

Money should be able to be divided into smaller portions in order to make transactions of all amounts.

Uniformity

Money of the same value should have the same appearance in the economy.

Acceptability

The form of money has to be acceptable to all parties in the economy.

Limited Supply

Money needs to be available in limited quantities in order for it to maintain its value. Otherwise, an oversupply of money leads to it losing its purchasing power.

The Evolution of Money Timeline

As we have seen how money has evolved, the course of this change was over long periods of time. Figure 1 below shows a timeline of the evolution of money.

The stages of the evolution of money include different forms of money throughout time. The origin of money was in tangible forms, and in recent years can also be found in intangible forms. Over time, as economies grew, it was evident that certain practices such as commodity money are not so efficient for conducting transactions. Other forms of money became more appealing as they not only satisfied the requirement for a medium of exchange but also helped the economy grow.

Let's take a look at how economies functioned and the forms of money that they used throughout history.

Fig. 1 - Evolution of money timeline

Barter Economy

Before the advent of money, societies used barter as a means of attaining goods and services. Barter is an economic system in which the members trade goods and services for other goods and services without using a medium of exchange. An example of a barter exchange would be a farmer who specializes in growing fruits trading with another farmer who specializes in growing grains. The two farmers would come to an agreement on how much fruit to trade for grains to meet their individual needs. It was hard for trade to happen, as it would require both sides to want exactly what the other person had to offer.

Commodity Money

As bartering was difficult for trade, some common commodities slowly took the function of money. Commodity money is an economic good that acts as money. Examples of commodity money throughout history included cocoa beans, tea, tobacco, salt, and seashells, to name a few.

Metallic Money

As societies and economies evolved, they found better ways to facilitate their trade and transaction. Metals such as gold, silver, and copper were used instead of commodity money. Metallic money was later standardized and certified in the form of coinage. The switch to metal money in the form of coins allowed for there to be a value associated with each type of coin. Coins were also portable, which made payments convenient.

Paper Money

The switch to paper is known to have originated in different parts of the world in different circumstances. In America, certain states allowed the citizens to print their own money. The state also printed money which was known as anticipated tax notes, that were used for buying supplies and other expenditures and for also paying out salaries. In other parts of the world, paper currency was backed by gold or silver. In America, at the time of the Revolutionary War, the Continental Congresses used fiat paper money called the Continental dollars. Fiat money is a currency that is only backed by government decree and nothing else, such as gold or silver.

Electronic Money

Evolution of Money and Banking

So far, we have discussed the evolution of money. However, another important evolution was the evolution of banking. The banking system in earlier economies constituted of institutions that served as banks, and the role they played was to keep records of trade activities and transactions. As economies advanced, these banks took on other roles such as lending. However, the banks weren't lending paper money, but rather lending seeds, grains, and other commodities of that nature.

Later down the line, banks emerged as merchant banks and still carried out the role of lending but also added other services such as financial advising, fundraising, and underwriting, to name a few. In much more recent times, as a standardized form of money, fiat paper currency became the norm for economies, the next step was to manage the supply of money and the security of money. This was done through the establishment of central banks.

Evolution of banking in America

In America, the banking system took flight after the Revolution through the new Constitution. State banks, which were private banks that received their operating charters from states, were now allowed to issue currencies by printing their own notes locally. During this time, once the bank circulated the currency, people had the option to exchange it for gold or silver.

Soon after the Civil War broke out, Congress started printing a new currency known as the "greenbacks" to finance the war efforts. Eventually, the greenbacks lost value, and people stopped using them. As a result of this, Congress was left with no choice but to find another way to fund the ongoing Civil War.

Congress established the National Banking System (NBS) by enacting the National Currency Act in 1863. A national bank was a private bank, but the federal government provided the operating charter. National banks issued a national currency that was backed by government bonds that the banks purchased from the federal government.

Through the implementation of the NBS, the government intended to gain the confidence of the members of the economy by having higher standards and rigorous bank inspections. Not only that, but the government was also able to fund the war through the NBS. As other banks joined, they would buy the bonds and create the cash flow needed for funding the war.

In 1865, the government implemented a 10% tax on privately issued banknotes. This strategy was implemented to compel other state-chartered banks to join the NBS and abandon their notes, which they did as they were unable to afford the government-implemented tax. Now the money supply in America shifted from privately issued currency to publicly issued currency.

The creation of the Federal Reserve System

As the country entered the 20th century, the NBS was no longer an efficient system to run an economy. To meet the new needs of a growing economy, in 1913, Congress created a central bank, which would lend to other banks, especially in difficult times. This new central bank is the Federal Reserve System, also known as the Fed. National banks were required to be members of the Fed, whereas state-chartered banks were eligible to become members.

The Fed was designed to be a corporation. When other banks joined, they would be required to purchase shares of stock of the Fed. This resulted in the ownership of the Fed not being with the government but rather private banks. A new currency, called the Federal Reserve Notes, was issued by the Fed, which replaced all other forms of currency within the country.