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History of Money

History of Money

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Published by Sukumar Nandi

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Published by: Sukumar Nandi on Mar 29, 2008
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Money : History and EvolutionMoney : History and Evolution
Sukumar NandiSukumar NandiIndian Institute of Management LucknowIndian Institute of Management Lucknow
 "The institution of money is,…….,a powerful instrument promoting wealth andwelfare" [ italics in original ]A.C. Pigou (1941), p.24Money in circulation, both paper and metallic currency, is the interest freeliability of the government
and against this there are claims to virtually nothing . Thisis because present- day money is hardly backed by gold and other foreign asset bythe government . This is fiat money and it is a legal tender, which the citizens of thecountry are legally bound to accept as a medium of exchange. So money in circulation isnot backed by government liability and the government has virtual monopoly on the provision of fiat money. Further, the government also controls the quantity of money.
In the historical context, fiat money is very recent in origin with a lifespan of a few decades. Its earlier form was commodity money. From history we find that useof gold as money began in the sixth century
B. C.
in Turkey. Lumps of gold found inthe river bed were melted and converted into pieces of uniform sizes and thenstamped to give it legal sanction. This is the early form of 
commodity money
with facevalue equal to its intrinsic value. The commodities chosen were generally preciousmetals with lighter weight for the convenience of carrying to distant places . Butsometimes seashells, cattle were also used as money. The technical characteristics of commodities selected to serve as money are of minor importance. But the importantthing is that there should exist social institutions condoned by customs and/or law thatenable the economic agents to trade efficiently by following the specific rule that onecommodity traded in every exchange should be socially sanctioned as an exchangeintermediary. In the money using economy the rule of the game is very precise thatcommodities buy money and vice versa ,but commodities do not buy commodities in anyorganized market ( Clower,1969).
Here the central bank's role is not neglected. Actually the central bank works on behalf of the government of the country. The concept of money as a fiduciary issue and a legal tender is true for all countries irrespective of the level of development .
The central bank enjoys hardly any autonomy except in a few countries and so it is taken as granted that the central bank follows the wishes of the government. Technically the currency in circulation are theliability of the central bank. 
Money in the Early Period
 The emergence of money in the early period can be known from the following :"In primitive traffic the economic man is awaking but very gradually toan understanding of the economic advantage to be gained by exploitationof existing opportunities of exchangeConsider how seldom this isthe case, that a commodity owned by somebody is of less value in usethan another commodity owned by someone else! And for the latter justthe opposite relation is the case. But how much more seldom does ithappen that these two bodies meet! …. Even in the relatively simpleand so often recurring case, when an economic unit A requires acommodity possessed by B, and B requires one possessed by C , whileC wants one that is owned by A -----even here, under a rule of mere barter , the exchange of goods in question would as a rule be of necessityleft undone ." [ page 242]Carl Menger (1892)In the early dawn of history when people realized the problem of barter, theystarted using precious metal as medium of exchange. In 2500
. the people inEgyptians produced metal rings for the use as money. By 700
. a Group of seafaring people called the Lydians became the first in the western world to makecoins The Lydians (of western Turkey, 700 637
) used coins to expand their vast empire . The Greeks and Romans continued to make coins and they passed thattradition to later generations. Greek Drachma was found in 400- 344
at Thessalyin Eastern Greece. In the eighteenth century trade and commerce increased inEurope and coins became wide in circulation. One of the most widely used coins wasthe Spanish 8 Reale and it was split into fraction like half a coin or 4 bits, a quarter was 2 bits etc.Metallic coins made of precious metal are the example of commodity moneyand it was acceptable because it had the intrinsic value. At times the metal value usedto differ with the face value leading to large scale hoarding or melting down of thecoins as the situation warranted.Paper money was first invented by the Chinese and it began in the T’angDynasty ( 618- 907
.). During the Ming Dynasty in 1300
, the Chinese placed the emperor’s seal and the signature of the treasurer on a crude paper . Thelatter was made of mulberry burke and it was of the size of a notebook paper. After theChinese the paper currency the experiment spread to other countries . Also
money was developed in some countries which are token or pieces of  paper that could be exchanged for a specific commodity such as gold or silver. Inthe later years of 19
century, the government of the USA and some Europeancountries issued gold and silver certificates. This type of money was very usefulto make large payments. Thus is seems that the authorities in those early yearsrealized the need for high denomination currencies to facilitate trade and commerce.
A Stable Numeiraire
One important aspect of commodity money is that it is a stable numeraire and ithelps keeping the price stability. Even Aristotle, in his book, Ethics, noted thatcommodity money was well suited for the price stability. According to him:“Money, it is true, is liable to the same fluctuation of demand as other commodities, for its purchasing power varies at different times; but it tends to be comparatively constant.”(Ethics, translation 1943)The commodity money system delivers a nominal anchor for the price level, and this isrealized through the profit-maximization principle. This was applicable in the case of mint producing coins in the middle ages and later. The mechanism can be as follows.Suppose there is a way to convert goods into silver and silver into goods at a constantcost, that is, in ounces of silver per unit of goods. This can be considered as (1) theextraction cost of silver, or (2) the world price of silver in case of small open economy.The mint converts silver into coins after the purchase of silver in bulk from the market, italso decides when to melt the coins to make it into silver bars. This is a private sector activity, and the rule of the government is limited to two actions. It specifies how muchsilver goes into a coin and it collects a seigniorage tax (Sargent & Velde, 1997).The profit maximization principle will dictate the private sector mint toadjust the revenue with the cost , the latter being the cost of buying silver bars from themarket along with the cost of production. This includes again the cost of labour. Againthe mint itself can be engaged in the extraction of silver, which determines the unit priceof silver. The revenue of the mint is the value of the coins produced and, assuming thateach coin is of the same weight, the revenue depends on the number of coins and their denominations. The mint will find equilibrium when the following equality holds::Market Value of Coins (or, the Inverse of Price level ) = Cost of Silver + Seigniorage Tax + Cost of ProductionThe above rule will ensure that the mint will continue minting coins. When this isviolated, i.e. the market value of coins is less than the combined total of the right handside, minting of coins will stop. This also determines whether the mint will producenew coins or start melting the existing coins, and this ultimately depends on how the price level relates to the following parameters : the cost of silver content, cost of  production and seigniorage rate. The price level can not go too low, or the mint couldnot make unlimited profits by minting new coins and spending them. Again, the pricelevel cannot go too high, or the mint would make profits by melting down the coins.Thus the absence of arbitrage facility for the mint places restriction on the pricelevel and this remain within an interval determined by the minting point and themelting point ,as shown in the figure (Figure 1). 
Figure 1. Price level within a domain
Minting Point
Melting Point 
Price LevelThe system described above has some unique features. Here the quantity of money isnot controlled by the government. The additions or deductions to existing money stock 

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