The USA is in a financial mess. One of the reasons for the mess is the simple fact that most of us who are citizens of this country have an extremely limited knowledge of economics and money. I see this daily in my conversations with friends and acquaintances. One of the objectives of this blog is to help individuals come to a basic understanding of the economic concepts which determine the quality of their lives. Because so few of us understand basic economic ideas, we are easily led by bankers and politicians into making personal and societal decisions that make our lives worse rather than better.
This post is about money because it is one of the most fundamental economic concepts which we deal with every day and yet do not understand. When we want something, perhaps to eat or to make our lives more comfortable, we peel off some of those green pieces of paper in our wallet or just use a plastic card which works as a kind of substitute these days. Mostly we just understand that the other party to our exchange will accept those pieces of paper or the plastic in exchange for whatever item we desire or need. But we must try to get to the fundamental concepts behind the willingness of two parties to make a mutually beneficial exchange.
I’m going to start with a primitive market which I did also in a previous post. In the most primitive of markets, there were very limited exchanges of goods. In fact, money was an unknown concept. Most societies were quite small and at the same time, self sufficient. That doesn’t mean that life was pleasant only that markets as we understand them, did not exist. A small society produced its own essential products needed for survival internally. Life was pretty difficult and there was little if any time for recreational activities. Almost all human activity was devoted just to keeping everyone alive, clothed and fed.
In these societies, it was apparent that food and water, the most essential requirements for life, were not always readily available. Eventually, some folks in these groups realized that food and water were more readily available at different times during the time cycles we understand as years. Some of the smarter people found ways to conserve and save food and water so that both would be available throughout the year.
Eventually the small societies began to come in contact with each other and to interact. Some of the groups were primarily farmers, others were hunters and others were fisherman. I’m sure there were other specialty groups. They began to trade amongst themselves but remember, there was still no concept of money. So the trading was simply a barter relationship. We have no way of assessing relative value but a farmer might have been willing to exchange a bushel of wheat for 5 medium sized tilapia (a fish). Exchanges like this were probably common. But suppose a hunter bagged a 600 lb elk and a 200 lb mule deer. This was more than his family group needed so he set out looking for an exchange. The farmer had only 10 bushels of wheat which the hunter recognized as not being equal to even the 200 lb deer. And time entered into the process. The deer meat which was probably considered more valuable but would rot much sooner than the wheat.
The point is that the barter process could effect an exchange but it was clunky and did not always meet the needs of both parties to the exchange. The small societies began to realize that it was possible to make indirect exchanges. That is, the hunter may not want or need 50 bushels of wheat for his 200 lb deer but the deer meat was a more time sensitive commodity than the wheat. By exchanging it for something that had longer lasting value, the hunter could get very close to the full value of his deer and have a product that would last longer and thus he could delay making another exchange until he knew what his next priority for an exchange would be.
The small societies were constantly searching for items or products that had lasting value. By exchanging their short life value products for other products that retained their value for longer time periods they developed a methodology to delay their final exchanges until they were more sure what would be most needed within their small groups.
These barter groups were constantly looking for items that would provide ever longer time periods before requiring an exchange. As the groups grew and refined their productivity, they came into contact with more groups with whom exchanges could be made. Each new group had the potential to introduce a new product for exchange. Over many years and many exchanges, the primitive markets began to develop into formalized exchanges and the possible exchanges began to develop into structured arrangements. These structures became possible after the precious metals had been discovered. The metals themselves had no intrinsic value but began to be valued simply because they were rare, beautiful and difficult to extract from the earth.
This discussion has possibly created the impression that the precious metals were a clear and early recognized item of exchange. This is not true at all. Different societies valued different items and the items valued changed with time. Such things as sea shells, bird feathers, arduously formed pieces of stone, and many other products were used as long lasting exchange items. It was only over a very long period of time (we do not know how long) that the two primary precious metals, silver and gold, became the most valued items across many multiples of societies as meeting the requirements of a long lasting and valued commodity that could be used to make indirect exchanges.
To understand gold (and less so, silver) as money, we need to consider how the barter process could develop into a more formalized exchange process. But the first step is to fully understand what gives value to any commodity. For example, gold has few uses that are naturally available to man. It cannot be eaten, provide shelter or protection of any kind and indeed, even today is used for very limited industrial purposes. Some folks have gold fillings in their teeth but in the time frame of these primitive societies, there were no dentists and no ability to process gold to use it in this capacity.
In fact, all commodities have value that is determined by large numbers of individuals making decisions about how desirable they are. There are, of course, those items that are necessary for survival. We all need food, water and shelter. Once these basic needs are met, individuals have more flexibility to express their individual desires. We can only guess at how many bushels of wheat would be required for the hind quarter of a 200 lb deer. But the reality is that depending on the desires of the two individuals involved in the exchange, one day it might require 4 bushels and the same trade could be made several days later for only 3 bushels. Of course as the meat is getting older its value is probably dropping.
But lets consider a more difficult trade. Suppose the hunter has just one hind quarter of his 200 lb deer remaining and what he really needs is a new pair of shoes. The farmer still has his wheat and is willing to trade 4 bushels for a hind quarter but the hunter would rather have new shoes so he can continue hunting. Enter a workman in a near by group who is willing trade an extra pair of shoes he just made for two bushels of wheat. As long as these three people can find each other in the proper time frame, a trade can occur. But you can imagine the difficulties involved if the three folks do not know each other and cannot find the correct trade in a time frame that meets the needs and desires of all involved.
If instead, there existed a product that was mutually recognized by all involved in the process as having the approximately the same value and at the same time kept its value for an extended period of time, then the hunter could exchange his hind quarter of deer meat for this product and not be concerned about possibly having to make an exchange first with the farmer. The workman could make a direct exchange for the meat and use this product later to make another exchange for the wheat he wanted.
Another difficulty that might prevent an exchange is when the value perceived by the two individuals in an exchange is not easily subdivided. Suppose the hunter just bagged a wild turkey and he was willing to exchange it for a half gallon of fresh water because he is thirsty after his hunting trip. He meets a man on the road with a gallon jug of water. They agree that a half gallon jug of water for the turkey is an agreeable exchange but neither of them has a half gallon container. It’s possible that no exchange will take place just because of the mechanics of the situation prevent the agreed exchange.
The difficulties of these barter exchanges can be overcome if a product exists that (1) is relatively scarce and thus has a generally recognizable perceived value, (2) is not easily used up (it is durable) or does not decay such that its value changes over time, (3) is relatively easy to subdivide such that the intrinsic character of the product is the same after it is subdivided as it was before, and (4) it is relatively easy to either store or transport it.
A bit of reflection allows one to see that gold and (to a slightly lesser extent) silver come extremely close to meeting all these parameters. Thus it should be no surprise to anyone that gold and silver have been among the most common products (commodities) used as a medium of exchange, otherwise known as money. Gold was valued by multiple civilizations even before the concept of money had been developed so it simply makes sense that its primary use eventually became the most used medium of exchange or money. While the first gold coins were struck in Lydia about 700 BC, it is only in the recent history of world civilizations that gold has become just a barbarous relic and is not treated as money by any government in the world.
Why this has happened is important and needs some discussion thus we will consider some of the more current developments in part two of Gold = Money?
Ken H. on 09.06.2009
It is possible that the use of barter or trade was possibly one of the major motivations for groups of humans to ban together and pool their skills thereby increasing their purchasing power as a result. Certainly self-defense was a motivation, but economics, as primitive as it was, also must have been a driving influence also. This arrangement would naturally have led very rapidly to other concepts which I am sure you are about to discuss like division of labor, socialism and capitalism. Bottom line: economics was the cause of civilization — not the other way around.