Friday, 20 November 2015 12:57

The Origins of Money

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The Origins of Money

Hans F. Sennholz

Dr. Hans F. Sennholz, former chairman of the Department of Economics at Grove City College, died June 23, 2007. Dr. Sennholz was a master teacher, incisive writer, gifted public lecturer and a friend of liberty. "The Origins of Money" first appeared in 2000 in a collection of essays published by Grove City College and is entitled, "Is Capitalism Morally Bankrupt?" This article is reprinted from Vision & Values, a publication of Grove City College, in Grove City, Pennsylvania.

Money owes its existence to the God-given inequalities of men. These inequalities lead men to cooperate with each other and engage in what economists call the "division of labor." The division of labor or specialization develops when men concentrate on what they do best and trade the product of their labor for other goods needed to sustain and enhance their lives. For example, a teacher who specializes in rendering educational services instructs young pupils. Obviously the teacher needs food, clothing, shelter, and hundreds of other economic goods to sustain his life and make him comfortable. But instead of single-handedly manufacturing them all, he specializes in rendering instructional services. How do the parents of his pupils pay for the instructional services? They could pay him by directly offering surplus goods they produce. The pupil whose father is a baker could supply bread; the farmer's daughter could bring farm produce. In fact, in early times schoolmasters were often paid "in kind." They engaged in direct exchange or bartering. While barter is a useful method of exchange, it is also very cumbersome and unsatisfactory in many respects. Suppose that our teacher needs a pocket watch, but the watchmaker has no children.

These predicaments that present themselves in a barter economy arise because the wants of the buyers and sellers do not complement each other. In order for barter to work well, one party to the trade must want exactly what the other party has to offer, and vice versa. One can easily see that barter, because of its serious limitations, points up the need of an intermediate good that is readily acceptable and marketable everywhere and at any time. Returning to our example, assume there was some valuable good which our schoolmaster would accept and in turn could use to purchase exactly the goods he wanted. Furthermore, if this same good could then be used by the merchant to purchase other goods, then that economic good used over and over again would be functioning as a medium or means of exchange. Money, then, is the "most marketable good" in the sense that it is willingly accepted in exchange because it can be easily exchanged again by its current owner.

Early Forms of Money

Our example clearly indicates that the selection of a certain good as money is a natural result of human economic activity. At the dawn of civilization, cattle were the most marketable commodity for many peoples. Although it seems strange to modern man, they were readily saleable and hence a natural money. Among the nomadic tribes of North and South America, other commodities that were acceptable to the largest number of people served as money, such as furs, animal skins or pelts, quills made of animal hair, articles made of feathers, wood or stone, tanning materials, medicinal plants and medicines. However, with the rise of towns and cities, pieces of metal gradually replaced cattle and other goods as money. There is no particular mystery about metals serving as media of exchange. They could be transported, divided and carried by a person, and small amounts of them were valuable. All these characteristics made metals the most saleable commodities and the natural monies of man. In many places copper, iron, silver, and gold became the most saleable goods and the most popular means of exchange.

In short, various goods with general usefulness and great marketability assumed the function of money. Although it differed in various locations, the money-character of certain commodities must be traced back to this usefulness and marketability. Neither prince or principality, nor law nor decree was ever needed to create money.

The Invention of Gold and Silver Coins

Money in the form of coinage first made its appearance in the 7th century B.C. Greek merchants in Lydia began to standardize the pieces of metal used in trade in order to eliminate the labor that was necessary to test and weigh raw metals at the time of each transaction. For centuries, these standardized pieces of metal were used, though they existed in many shapes and sizes. Authenticity was established by afffixing the stamp of certain well-known mercantile families to the pieces of metal.

Political intervention has plagued the coinage system ever since. Guided by innate baser human inclinations and predilections, government leaders of all ages have been drawn to the mints. To pay for military expenses, mercenaries, arms and equipment, they struck coins on which they made large profits by charging a large difference between the value of the bullion used and the face value of the coin. The difference is called "seigniorage." They also discovered that their monopoly over the mint could be used to obtain additional revenue through coin debasement. Claiming authority over the mint in order to supervise the true weight and purity of the coinage, they themselves yielded to the temptation to debase the coins. After all, there was no higher authority that could restrain the malefactors.

The Modern Era -- Bank Notes and Fiat Money

Throughout the ages, one of the problems businessmen coped with was the safe transfer of money from one location to another. Roaming gangs of robber barons, brigands, and thieves made it almost impossible to send quantities of coins to distant locations. These dangers and difficulties were largely overcome by the development and use of bills of exchange and other paper instruments, which were the forerunners of modern paper money. In the ancient world, crude papyrus notes and clay tables functioned as promises to pay precious metals on demand. In modern times, the early goldsmiths began to issue paper receipts -- later called bank notes for gold and silver deposited with them for safekeeping.

Unfortunately, as people grew accustomed to paper money as a substitute for gold and silver, government soon claimed the sovereign right to regulate and even monopolize the issuance of money substitutes. What began as an avenue of escape from coin debasement was to become an important means of debasement and depreciation by government. In this country, government took an early step toward full government control of money substitutes during the pre-constitutional period and again during the Civil War. At first state governments and later also the federal government passed legal tender acts. These laws required citizens to accept governmentally issued money in exchange for valuable goods and services no matter how much the paper substitutes had depreciated.

The Phases of Inflation

In its first phase, inflation of the money supply by government triggers economic booms that bring excitement and opportunity. It triggers bull markets on Wall Street, promising increase and fortune to millions of investors. It stirs businessmen who may profit from soaring demand and rising prices. Newly created money exhilarates bankers as it generates bigger deposits, bigger loans, and bigger balance sheets. It energizers labor unions that deliver marvelous pay boosts to their grateful members. Lastly, inflation whether slow and gradual or rapid, makes politicians the happiest of all. Inflation erases part of the past government debt because government can pay back those who lent it money with dollars which are worth less than before. In summary, the first phase of inflation is like drug addiction, creating euphoria that takes hold of its victims and transports them into a "never-never land."

Phase Two -- The Effects Set In

The American people have come to accept inflation, especially the first stage of it, as a way of life that refreshes, creates, and enables. But unfortunately, as inflation continues, it reveals some undesirable characteristics. Inflation, as it nears the end of its jubilant first phase, begins to raise the costs of living and simultaneously lowers the standard of living for many citizens. Of course, at this point the federal government, which is conducting the inflation, seeks again and again to eliminate the results of its policies. Politicians and officials try to talk down the consumer price index by threatening large visible businesses that propose price increases. Some officials even "declare war" on inflation.

But such efforts, short of a legal freeze on prices, have little effect. The prices of goods must rise when more money enters the cash holdings of the people. This is so because people tend to spend more when they receive more. But, to return to the point, how do levels of living decline for many citizens in the second phase of inflation?

1. Creditors lose and debtors win. A creditor is one who is owed money, and, of course, a debtor owes money. In a period of unanticipated inflation, a creditor is hurt because he lends dollars with a certain purchasing power. When he is repaid six or twelve months later, the dollars he receives in repayment have less purchasing power than those that he lent. Therefore, he is worse off than if there had been no inflation.

2. Fixed income recipients lose. Pensioners and retirees depend for their monthly income, in whole or in part, upon payments that are usually fixed at a certain number of dollars. When, due to inflation, the dollars depreciate each and every month, the fixed income, though nominally the same, will buy less and less. It is sometimes said that inflation is kind of a "hidden tax" upon such recipients.

3. Savings in money form are lost. Before the age of inflation, those who restricted their present consumption and saved would put their savings into a bank account without much fear it would be lost. Moreover, interest income would most certainly be produced from such thrift. However, in an inflationary period, savers who save in the form of money or claims to money, such as a $500 savings deposit account, find that with the passage of time, the savings are eroded. True, at the end of six months or twelve months they are free to withdraw their savings of $500 from the deposit account plus interest. However, those $500 may purchase 10 percent or 15 percent fewer goods, because the inflation has depreciated their savings and the interest likely will not even cover this loss of value.

Inflation's Final Phase

As inflation continues doing harm to creditors, fixed income recipients and savers -- in other words, to the middle class -- three possible things can happen in the final phase: (1) runaway inflation (2) the quack cure of price controls or (3) true moderation in fiscal and monetary policy.

In our own American history the worst runaway paper money inflation was the Continental dollar inflation that resulted when the Continental Congress printed the bills in profusion from 1775 to 1781. The effects of such monetary irresponsibility were seen in the contrast between hard money (gold or silver) prices and paper money prices of the same good in that era. In 1781, one could buy a bushel of wheat for six shillings in hard money. However, if one were paying in Continental currency (paper), one would have to pay 600 shillings per bushel. When such inflation occurs, citizens engage in a "flight to real values," which is to say that they prefer anything to the paper money.

Two modern European inflations demonstrate how inflation follows its complete destructive course: the German inflation of 1914 to 1923 and the French inflation during the Revolution of 1789. In both cases the currency was completely destroyed. At its end, German workers sought payment daily or twice daily in order to enable their wives to make immediate purchases of real goods before the paper money depreciated further! Likewise, the French "assignat" inflation reduced a Frenchman's entire savings to an amount that was barely enough to buy a meal.

Another step often taken as inflation rages into its final phase is the imposition of price controls by the state. The rapidly rising prices that accompany monetary inflation are the target of such controls. Prices are "going up too fast," say the politicians. "Let's make price increases illegal," they say. The use of price controls is a quack cure. Meanwhile, the true cause of rising prices -- monetary expansion made necessary by deficit spending -- is not being dealt with.

A third option is for the citizenry and their government to practice moderation. The real cure for monetary inflation is to deal with its true cause: excessive spending financed by red ink fiscal policy. Such restraint takes economic understanding in an age when government deficits, financed by newly created money and credit, have become so common.

Inflation -- The Moral Question

Ultimately, however, the question of inflation versus sound money is a moral one. At its root, inflation is politically immoral and dishonest. A dedication to inflation transgresses the immutable principles of justice, fairness, consideration and cooperation. It generates economic, social and political conflict. When inflation runs rampant, economic life is bound to deteriorate, the levels of living must tumble, democratic institutions crumble, and the civility of social life wears away.

In the end, inflation repeals all principles of virtue. *

"In order to become the master, the politician poses as the servant." --Charles de Gaulle

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