CHAPTER 1

HISTORY AND MONEY EVOLUTION

 INTRODUCTION
Money is very important for any economy. Through money, players in an
economy are able to buy whatever goods and services they need without the
hassle of bartering.

Money is fundamental in the functioning of an economy. It facilitates the

exchange of goods and services, and reduce the amount of time and effort to
carry out a transaction. Whereas, a monetary policy is the process by which the
central banks control the supply of money to maintain price stability and
economic prosperity.
 BARTER TRADE SYSTEM
Exchange is the process of give-and-take in the transfer of goods and services with others.
What is barter system?

The history of economic exchange started by means of simple direct exchange, that is, primitive
barter trade between two parties. A barter system is an old method of exchange. This system has
been used for centuries and long before money was invented. People exchanged services and
goods for other services and goods in return.

It is a very crude form of exchange of in which one gives up something less desired for
something more desired. In this regard, economist economists would say giving up something of
lower marginal utility in exchange of something of higher marginal utility.
 A barter system is an old method of exchange. This system has been used for
centuries and long before money was invented. People exchanged services and
goods for other services and goods in return.
In essence, an exchange involves the transfer of ownership since in exchanging things, claims on
property rights are exchanged.

However, for larger societies with loosened social ties, more focus on individual well-being, as
well as having a large amount of goods and services for exchange, primitive barter is like to be
deficient as the supporting exchange mechanism.

The reason for this inability and weakness of barter economic system summaries as follows:
1. Double coincidence of wants
2. Indivisibility of goods and services
3. Lack of unit if account (common standard value)
1. Double coincidence of wants
This refers to the situation where one is likely difficult to find a counterparty who is offering what
one desires, and at the same time is willing to accept what one is offering in exchange. Imagine a
furniture maker who wants a chicken: hence, approaches a poultry farmer to make an exchange. The
first problem is that the farmer might not need any new furniture; hence, might not be willing to accept
such a trade. If the furniture maker has nothing else to offer to the farmer , then an exchange might not
take place at all.

2. Indivisibility of goods and services

Continuing with the above example, say even if the farmer wants new furniture, the exchange ratio
of a furniture for one chicken might not be acceptable to either or both the parties. For example, the value
of a chicken may be equal to a quarter of the value of the furniture, but how pieces would adversely
impact the farmer’s supposed utility. Hence, the farmer’s incentive for exchange is dampened.

3. Lack of a unit of account (common standard value)

Another problem that could impede exchange in a primitive barter marketplace as diversification
of products grows, is that of pricing. With a limited amount of products, this problem might not
be apparent.
 THE CONCEPT OF MONEY
• The concept of money introduced in order to solve the problem of barter exchange and to
facilitate trade. Money gad emerged as early as records and archaeological finding go back into
mankind’s history.
• Shells, feathers, stones, leather and many other items as well as various recording methods
have been used ad ways as means of simplifying the exchange process.
• Yet, barter would make a comeback at times-whenever the monetary exchange mechanism
failed to perform, people would fall back on to various form of barter.
• In the 1970s, the US saw a revival of barter due to the high inflation rate at that time, and in
early 1990s, the Russian population had to resort to barter due to a total breakdown of their
national currency system when the Soviet Union collapsed.
• Also during 1997 East Asian Economic Crisis, Malaysia resorted to barter in international trade
due to a shortage of foreign reserves.
 FUNCTIONS OF MONEY
The most important functions of money are to serve as unit of account and a medium of
exchange. However, depending on what is being used as money, it could also serve as a store of
value and a standard of deferred payment.

Medium of exchange
The most important function of money is its function as a medium of exchange. Once an object
ceases to circulate in the exchange process, it ceases to be money. Gold is an excellent example.
It once play the role of money in all civilisations, but is now rarely used as money.

Unit of account
Pricing in primitive barter is very cumbersome and makes exchange impractical and almost
impossible in a market with a very high amount of goods and services.
Store Value
• Money must be able to preserve its value in the exchange process, and thereby allow one to
obtain the same value back when the money is transformed back into real goods and services.
If the purchasing power of money eroded over time, then that money has not been a good store
of value.

• Since inflation is a measurement of the purchasing power of money, it is therefore used as a

measure to estimate the performance of money as a store value. If the general price level is
stable, which is equivalent to low or no inflation, we can say that money has been a good store
of value.

Good money is supposed to store its value. It means good money can be saved
and used at a later time without facing a diminished value. However, in reality, at
present, money as we commonly recognise it, does not hold such characteristic.
For instance, a 10 sen coin in 1970 could buy one a cup of tea in Malaysia;
whereas, in 2010 it could at best get one only a glass of water. Indeed, in many
restaurants a glass of iced water now costs 30 sen or more.
 TYPES OF MONEY
Different types of money emerged and functioned throughout the history of mankind.

1. Commodity money
Commodity monies might be defined as commodities which are used to facilitate the exchange process.
Historically, various commodities have played the role of money. Rice was used as money in the 17 th
century feudal Japan. They used noted that were redeemable for rice. Similarly, the states of South
Carolina and Virginia in the US has used rice notes, respectively as money in the 18 th century.

Problems in commodity monies:

• Expense involved and the difficulty in transporting them.
• Storage cost.
• Variation in the qualities of money.
2. Metallic money
Eventually, precious metals that are more homogeneous in nature, particularly gold and
silver, came to dominate as money over other commodity monies. Gold and silver were
commodities found very desirable to play the role as money.
3. Fiat money
Money that is legalized as a medium of exchange by the government such as coins and
moneylenders issued by the central bank.
Initially, paper money was issued to gold owners based on the amount of gold deposited into
the trading bank account. In keeping with the passage of time and time, banknotes are no
longer issued by the bank based on the amount of gold deposited in the bank. This means
that

Commercial banks make money without collateral for gold. Today, the withdrawal of paper
money is no longer made by the commercial banks but is taken over by the Central Bank.
 CHARACTERISTIC OF MONEY

1. Divisible
The money cab be easily divided into smaller homogeneous units, as well as can be merged back into bigger units without
loss of value.
2. Fungible
All monetary units are of equivalent value.
3. Weighable, measurable or countable
The lowering of the quality of money should not be possible or at least easily detectable.
4. Stable value over time
The money can be held for relatively long periods of time without losing the purchasing power.
5. Durable
The money should last for long periods of time without being spoilt or destroyed chemically due to weather, heat, pressure
etc, or biologically, due to bacterial activity and so forth.
6. Homogeneous
The money if divided into smaller units would contain similar matter, such that one part should not be favoured over
another. For example, if rice was used as money, a scoop of rice from one part of the sack should be valued the same as
scoop from another part.
7. Mobile
The money should be easily movable from one place to another.
 EVOLUTION OF MONEY
FIRST STAGE

Barter System
In the days of the barter trading system, the basic unit of exchange in the financial system at that time was
commodity money (food, defense, jewelry, and tools that assisted in everyday life) and then metal money. These
commodity and metal coins serve as account units and value units to facilitate trade and accumulate wealth.

Goods like furs, skins, salt, rice, wheat, utensils, weapons etc. were commonly used as money. Such exchange of
goods for goods was known as ‘Barter Exchange’.
Commodity Money
People usually search for ways to make transactions easier. They
found out later that using certain items as a medium of exchange
made it easier to transact business. People used salt, leather,
tobacco, palay and other commodities as accepted payment for
different items. These are referred to as commodity money.

Metallic Money:
With progress of human civilization, commodity money
changed into metallic money. Metals like gold, silver, copper,
etc. were used as they could be easily handled and their
quantity can be easily ascertained. It was the main form of
money throughout the major portion of recorded history.
SECOND STAGE
Paper money
It was found inconvenient as well as dangerous to carry gold and
silver coins from place to place. So, invention of paper money
marked a very important stage in the development of money. Paper
money is regulated and controlled by Central bank of the country
(RBI in India). At present, a very large part of money consists
mainly of currency notes or paper money issued by the central bank

Paper money issued by a goldsmith or bank. It arises when it comes

to the practice of borrowing from a fund raised by an income earner
to an individual or enterprise with a service charge or interest.
At this stage there is a flow of funds from surplus units to deficit
units (direct loans). In direct lending, the excess unit carries the risk
of a bad debt repayment.
THIRD STAGE
As a result of direct lending weakness, financial intermediary institutions are formed. The
institution's liability is known as secondary debt or indirect loan.
These financial intermediation institutions earn from interest rates imposed on borrowers.
Whereas depositors will get a return on their savings from the dividend rate set by the financial
Institution. The difference in interest rates and dividend rates is an advantage to the institution.

The first bank established was a commercial bank where it focused on specific areas such as trade
finance. In line with current developments, several financial intermediary institutions have been
established such as merchant banks, savings and pension funds, finance companies, insurance
and others.
FOURTH STAGE
The last stage is the maturity stage for financial intermediation institutions. At this stage, these
institutions offer various financial tools as savings media for surplus units and various credit and
investment facilities for deficit units.

Households are a group with large surplus units, they save most of their income.