What is money and what is it worth? We take a look.
Have you ever looked at that familiar phrase written on every Bank of England banknote, which says "I promise to pay the bearer on demand the sum of Ten Pounds" (or whatever the denomination), and wondered what it actually means?
Well, it's an important part of the history of money, and how modern currencies came about.
In ancient times, of course, people traded by barter. If one family or tribe raised sheep, and another made flint knives, when time for Sunday dinner came round, it made a lot of sense for each to trade some of their produce with the other, so that everyone could have a nice bit of meat and the tools to prepare it.
That would be less convenient should you, say, be a fletcher who needed your shoes repaired, but the cobbler didn't want any arrows, and instead fancied a nice bit of lamb. You might end up having to trade your arrows for some flint knives, then swap them for some chops to take to the cobbler.
Commodity money
No society would have got very far without a universally accepted token of exchange, and many have been adopted, usually based on some sort of commonly accepted commodity. The most obvious examples are precious metals, especially silver and gold, which were given value because of their scarcity (even if they had little practical use other than to sit there and be shiny).
Trading systems arose whereby goods and services were priced in amounts of gold, silver, copper, and all sorts of things -- all that was really required was that the "money" substances be easily portable, non-perishable, and hard to obtain.
Coinage in precious metals was issued, so people could know they had a predetermined amount of it at the appropriate purity. The earliest use of stamped coins made from precious metals is currently thought to date to at least 600 BC.
There were many problems with such systems, including forgery, "clipping" -- in which people actually shaved bits of gold and silver off the edges of the coins, leading to the milling of coin edges to make it impossible to hide, and the sheer burden of carrying heavy bags of metal around with you.
Gold standard
As the world developed and financial transactions became ever more complicated, something more convenient was needed, and systems of what is known as Representative Money arose -- in the form of banknotes, and coins made from low value materials. Although we may think of banknotes as a relatively recent invention -- they came into use in Europe around the 17th century -- the earliest recorded paper money is thought to date to the Chinese Song Dynasty, around the 10th century AD.
Instead of the currency itself holding value, banknotes represented a value in real commodities for which they could be exchanged. So instead of handing over, say, a pound of silver for a large transaction, you could present a note written by your bank which promised to pay the bearer the actual metal upon presentation -- the heavy silver stayed in the bank, while all you had to carry around was a "silver token" printed in paper.
And that's where the "I promise to pay..." thing comes from. At various past times, you really could present a £1 note to the Bank of England and walk out with your pound weight of silver, or exchange a £5 note for five gold sovereigns.
But today, the idea of tying the value of money to a commodity like gold or silver is long abandoned.
Fiat money
Instead, we use a system of money whose amount is declared by government order, or fiat, and it has no intrinsic commodity value at all -- all you can exchange notes for at the Bank of England these days is more notes or coins of the same stuff. Central banks are able to issue as much or as little money as they wish, leaving the free market to decide on its value in exactly the same way as it values other goods and services.
When we looked at Quantitative Easing recently, we saw how central banks can increase or decrease the money supply to try to achieve whatever monetary goals they desire -- be that steady inflation at a set target, stimulation of liquidity, or whatever.
Under a fiat money system, government controlled central banks are in sole charge of the money supply, and are able to create and destroy as much of it as they like -- we'll take a look at modern aspects of the money supply in a later instalment in this series.
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