#21. Money, Money, Money. Oh It's Funny!

The erosion of money is the erosion of social order.

Money is a funny thing. We’re all born into it. I don’t mean wealth. I mean money.

We don’t really understand it and we rarely question it. All we know is that we earn money, we spend money and maybe we save some too. Other than that, the vast majority of people living on this planet have no idea of the concept of money. With this piece, I plan to layout the evolution of money, the true purpose of it and what it all means.

Evolution

When you think of money, perhaps you think of the paper notes we withdraw from ATMs or the coins we’re left with after a transaction. We only think of money as the “paper kind” because this is what we know and what is part of our daily lives. If, or most likely when, paper money is phased out, the youngest generations will start to think of money as “cards” or digital forms. Paper won’t even be something to reference for them. We may even be the last generations who think in coins and paper when referencing money. Before “us”, money was gold, silver, copper. Before “them”, money was chickens, cattle, stones. The more you go back the more different “money” is. In one such case in Micronesia, the Yepese would use large rocks, Rai Stones, as a form of money.

Commodity money was first used by the ancient Mesopotamians around 3000 BC. The money? Barley. People would barter, exchanging goods and services directly—grain for cattle, tools for textiles etc…The system was efficient only when each party had something the other wanted.

Trade only worked when all parties had what the others wanted.

As societies expanded and trade networks grew, the limitations of barley and perishable goods became apparent. This created inefficiencies, leading to the development of commodity money. Precious metals like gold and silver became early forms of money as they were universally valued and could be easily traded. The Lydians, in what is now modern-day Turkey, are credited with minting the first official currency around 600 BCE, which was made from a naturally occurring alloy of gold and silver known as electrum. Pretty cool.

Societies continued to expand and the use of money became more sophisticated. Coins minted from precious metals became standard. Coins were vital in facilitating trade over larger distances and among more people.

As money evolved, so did it’s purpose. It’s usage wasn't just limited to transactions; it began to influence social structures and power dynamics. For centuries, the possession of money and wealth determined one's social standing.

The Romans developed and improved their coinage, creating vast systems of mints and standardized currency to facilitate trade throughout the Empire. The Denarius, a silver coin, became the backbone of the Roman economy. It’s successes spread throughout Europe, influencing monetary systems for centuries.

Paper Promises and Banking Systems

The introduction of paper money was a pivotal development. China, was the first to use paper currency in the 7th century during the Tang Dynasty. Previously, the value of the coin was determined by the metal and it’s weight. Paper money represented a promise of value, meaning that the paper itself had no value but what the paper was backed by, precious metals, did. The idea caught on. Paper money was less cumbersome and the real value could be held safe and secured, rather than on oneself, making the risk of theft much lower.

The development of banking systems allowed for safer and more efficient money handling, including loans and credit, which further fueled economic growth. Again the Chinese, this time the Song Dynasty in the 11th century, advanced the use of paper money further, issuing notes that could be exchanged for hard currency. Marco Polo and his ilk liked the idea so much, they helped introduce it to Europe in the 13th century. However, it wasn’t until the 17th century that European countries began adopting paper money, with Sweden’s Stockholms Banco issuing the first European notes in the mid 1600s.

The Chinese innovated money, transitioning from direct value to promise of value.

The establishment of central banks marked another crucial development in the history of money. The Bank of England, founded at the end of the 17th century, was the first central bank to issue banknotes that were backed by the government. This innovation provided a more stable and trustworthy form of money. Central banks have since become commonplace in modern financial systems, responsible for regulating money supply and maintaining economic stability.

The Gold Standard

As I mentioned earlier, the value of money was often tied to tangible assets like gold or silver. Whether that was the actual metal used for the coin or the commodity used to back the paper money, the value of the money was always tangible, in that the coins value was tied directly to the metal and weight that formed it, and the paper was effectively a token that was exchangeable for the weight of the precious metal that the note represented.

The Gold Standard, which pegged the value of a currency to a specific amount of gold, provided stability and trust in the monetary system. However, during the 20th century, many countries moved away from the Gold Standard. This was a fork in the timeline.

The United States officially abandoned it in 1971 under Nixon [of I’m not a crook fame], transitioning to a fiat currency system where money's value is not backed by physical commodities but rather by government decree. The decision to abandon the Gold Standard was influenced by various factors, including the need for greater flexibility in monetary policy and the pressure of international financial dynamics. A critique of the Gold Standard was that it constrained economic growth and led to deflationary pressures. The move to fiat currency allowed governments to, supposedly, better manage economic cycles, but it also introduced risks of inflation and devaluation.

While the move to fiat currency allowed for greater economic flexibility, it also introduced several risks and challenges. The loss of intrinsic value under the Gold Standard, where the units of currency were backed by a specific amount of gold, made fiat money dependent on government decree and public confidence. This shift makes the value of money less secure, as it relies on unpredictable and uncontrollable cirucmstances.

The flexibility of fiat currency allows governments to print more money as needed, which, as we’ve seen, can lead to inflation if not managed properly. In extreme cases, this can result in hyperinflation, where the value of money plummets rapidly, leading to economic chaos. Well known examples include the hyperinflation in Weimar Germany in the 1920s and more recently, Zimbabwe in the 2000s.

The Gold Standard imposed a natural limit on the amount of money that could be created, acting as a check on government spending and borrowing. Fiat currency meant there was no limit, which can lead to less fiscal discipline. As we saw during Covid, Governments may be tempted to finance deficits through money creation, leading to higher debt levels and potential economic instability.

Without the constraints of the Gold Standard, governments can devalue their currency to gain a competitive advantage in international trade. While this can provide short-term economic benefits, it can also lead to a "race to the bottom" where multiple countries devalue their currencies, ultimately harming global stability.

Under the Gold Standard, international transactions were simplified because currencies had a stable value relative to each other. The move to fiat currency introduced greater volatility and uncertainty in exchange rates. This complicates international trade and investments, burdening businesses and investors with FX risk. The biggest benefit of fiat currency, greater flexibility, is actually a key contributor to financial instability.

For example, the ability to rapidly expand the money supply can lead to asset bubbles, as seen in the housing market before the 2008 financial crisis. We are likely living in one right now. When these bubbles burst, the economic consequences are severe.

The removal of the Gold Standard removed tangible backing to money, leading to funny money.

The transition to fiat currency also exacerbates wealth inequality. Inflation tends to erode the value of savings, disproportionately affecting those with fixed incomes or savings held in cash. Meanwhile, those with investments in assets such as real estate, stocks, or commodities see their wealth grow.

Here is an important aspect to consider when thinking about money. We moved away from the Gold Standard, yet wealthy people and nations still hold Gold. Meanwhile non-wealthy people hold cash. If cash is king, why do the wealthy not hold it?

The Future

Today, money is being reinvented. It is less about physical coins and notes and more about digital transactions. Cryptocurrencies, lead by Bitcoin are challenging our traditional notions of money by offering decentralized and, in some cases, deflationary alternatives. Hint: It’s Gold version 2.

The rise of digital transactions and crypto is a significant shift in how we perceive money. Bitcoin, introduced in 2009 by an unknown person/persons known only as Satoshi Nakamoto, was the first decentralized form of digital money. It operates with no central authority, offering a form of money that is secure, transparent, and potentially deflationary. It’s also highly divisible and easily transportable. Other cryptocurrencies have since emerged, each with unique features but mostly less tangible value and utility.

Since 2009, Bitcoin and cryptocurrencies have rapidly become mainstream. In response to the growing influence of cryptocurrencies, many central banks are exploring Central Bank Digital Currencies (CBDCs). I wrote about this in a previous post.

These digital currencies would be issued and regulated by central banks, combining the benefits of digital money with the stability of traditional financial systems. Countries like China, Sweden, and the Bahamas are already in various stages of developing and testing their own CBDCs. However, beware that CBDCs contain the same consequences of fiat money coupled with additional central bank control. Read the previous post in the link above to understand CBDCs.

Funny Money

National debts are skyrocketing, with interest expenses eating into government budgets, leaving less for public services and infrastructure. Right now, the interest expense on US Debt is the highest expense on the government balance sheet. Almost ONE TRILLION DOLLARS…PER YEAR!

The burden of this debt is shouldered by us, the average citizen, through higher taxes and reduced benefits. Meanwhile, the wealthy protect their purchasing power by investing in assets that appreciate over time.

Do you see the trick? The wealthy don’t own “money”, they own assets. Why? Because the value of “money” thanks to the central bankers and their fiat standard, erodes at a rate of 10% every 5 years. Meanwhile asset prices rise exponentially.

We went from trading commodities like Barley and Cattle - tangible value - to coins made of precious metals - tangible value - to paper money backed by precious metals - tangible value - to fiat money backed by promises, intangible made up funny money.

$20 means nothing because $20 today is different to $20 tomorrow.

Conclusion

The evolution of money has led to innovative ways for merchants and consumers to trade goods and services whilst maintaining wealth. Throughout history, governments have tried to manipulate money. The romans would famously dilute the amount of precious metals in their coin, making coins worth less. Nowadays we increase the money supply, making each note worth less than it did yesterday.

The concept of money has changed though history from something of value to something without. Whilst the rich and wealthy swap their money for real value such as metals, stocks and other value bearing assets, the average citizens save and hold money, making themselves poorer over time.

Money is important but understanding money is even more so. Once you understand what money truly is, you will get rid of as much as you can at the first opportunity.