Money

Money, get away
Get a good job with good pay
And you're ok
--Pink Floyd

When civilization began, it did not take individuals long to determine that they would be more prosperous if people specialized when producing output. Gains in productivity obtained from specialization enabled all to be better off as long as producers could trade their output amongst themselves to obtain the diversity of goods and services necessary for better standard of living.

Early trade involved exchanging goods for goods. Today, this type of exchange is known as barter. People who chopped wood traded a portion of their incomes (i.e., logs) with people who baked bread. When they traded their specialized production, both lumberjacks and bakers became better off.

The direct trading of goods for goods presented some problems, however. Sometimes it was difficult to trade goods evenly. Perhaps one house was deemed to be worth 3.25 boats on the market, and it was difficult to trade a fractional house or boat. Spoilage was another problem. Many food producers were limited in trading capacity because their output had a limited shelf-life. That put them at a disadvantage on the market.

To address such problems, people created money to improve the fluidity of exchange. Money in this sense serves as a medium of exchange. The idea is intuitive enough: convert the value of goods into quantities of money and trade should flow easier.

Commodities became intuitive forms of money. Livestock, salt, eggs, and wheat functioned as mediums of exchange in some societies. In colonial America, tobacco was used as money.

Because commodities are products themselves, many of these early forms of money suffered from problems familiar to goods-for-goods trade. Some commodity monies were not readily divisible. Others were hard to recognize or subject to decay. Lack of portability made some commodity monies difficult to carry around.

Most commodity monies also lacked this important quality: scarcity. If a money is abundant and can be created easily, then prices--a key element of market structure--are unstable and difficult to predict as the supply of money changes. When money is easy to create, it is also subject to mischief--particularly mischief of a political nature.

Over time, the search for an effective commodity money has led many societies toward a particular solution: gold. Gold possesses all of the qualities of good money. It is divisible, portable, durable, recognizable, and scarce. It is difficult to produce legitimately and to counterfeit illegimately.

Although many gold-backed 'hard money' designs have existed throughout history, gold rarely serves as money today. In fact, there is not a single monetary system in the world that is currently backed by gold. The backstory as to why gold-as-money has fallen out of favor is a subject for another day.

In contemporary monetary systems, gold has been replaced by currencies that can be created out of thin air by government fiat. On the plus side, contemporary monies, such as the paper form of the US Dollar officially known as Federal Reserve Notes, facilitate huge volumes of trade on a daily basis. On the negative side, fiat monies are subject to politically-motivated manipulation that serves to debase monetary value. This is the other function of money, btw--it serves as a store of value. Debasement of money distorts markets in the short run and creates potential for enormous socio-economic problems in the long run.

Because of the centrality of money to trade, investors benefit from solid understanding monetary of history and of the pros and cons associated with contemporary monetary systems. We will surely focus more on monetary issues in future posts.