The Evolution of Money

The evolution of money is important to understand when exploring the financial, economic and political systems that drive monetary policies.

Monetary policies affect the economy, and the economy affects our personal investment outcomes. Let’s review the common steps of money evolution.

Stage 1: The Barter System - Evolution of Money
Barter was a common form of money in primitive and beginning societies (although it is occasionally used in advance societies) where one good or service is exchanged for another.

A barter exchange is usually bilateral, but may be multilateral.
For example, in a bilateral transaction a cobbler may exchange a pair of shoes for a chair from a carpenter. The barter has some difficulties. What if the pair of shoes is worth more than the chair? How does the carpenter give change for the difference? These can be challenging questions.

In a multilateral transaction three or more people exchange goods and services between each other. This transaction can get even more complex. Each person who wants to trade needs to find someone else who needs their goods (or services) but the original trader may not need that other person’s goods. Matching up needs may require multiple parties and products.

Consequently, the barter system is somewhat inflexible. This encourages societies to create a more flexible money system where goods and services are exchanged indirectly. Commodity and fiat moneys are two common ways of doing this.

Note: A barter system may augment, or replace money as a method of exchange in times of monetary crisis. A crisis may occur when the currency becomes unstable (i.e. hyperinflation or deflation) or becomes unavailable for conducting transactions (banking holidays due to runs on the banks etc.).

Stage 2: Commodity Money - Evolution of Money
This is money that has its value created from any commodity that backs it. It is the strongest most stable type of money for a couple of significant reasons:

• Having a tangible commodity backing the money supply lends a sense of security. People know they can exchange paper money or coins for something that has intrinsic value.

• It is more difficult for politicians to easily debase the money supply though deficit spending with a commodity backed money supply.

Wide arrays of items throughout history have backed commodity money. Tobacco, sea shells, livestock and a host of other items have been used as commodity money because of their intrinsic value. Even today cigarettes are used in prisons as a form of commodity money.

Precious metals (especially gold and silver) are the most common and stable items backing commodity money because they have certain characteristics that make them attractive or useful to almost everyone.

Gold and silver can be measured in precise quantity, purity and are easily divisible. They are a storehouse of value and can be exchanged at a later time for something else. During times of economic turmoil they are a critical component of wealth management and preservation.

Stage 3: Currency Debasement - Evolution of Money
Currency debasement is the practice of lowering the value of money. It has been used by monarchs and politicians for thousands of years to minimize the burden of huge debts without inflicting major taxes on their subjects or citizens. Currency debasement eventually turns a strong commodity backed money into a fiat currency.

In other words, debasing a currency is done for financial gain of a government over the expense of its citizens. Since the beginning of modern banking and the invention of paper money starting the 1600’s governments learned the power of the printing press to create money out of thin air.

Stage 4: Fiat Currency - Evolution of Money
Fiat money has no intrinsic value. It is money (usually paper, or coinage) that has no commodity backing. It acquires its value from government decree that it is legal tender. In other words the only reason it is valuable is because people trust in their government.

The primary concern that the advocates of a commodity money system have is that fiat money can become valueless if the populous loses faith in the government. There is compelling evidence to support this position since this has occurred many times throughout history.

Stage 5: Fiat Currency Chaos - Evolution of Money
Throughout history many currencies have failed when they have gone to a Fiat Currency. If not complete collapse, they will go thought significant redenomination, debasement or devaluation.

The temptation for governments to crank up the printing presses for war, projects, graft and more has been so great that it is almost inevitable.

Stage 6: Creating of a New or Modified Monetary System
This can cause a great deal of societal upheaval in the process. A country may go back to a commodity monetary system or it may try to use a Fiat Money system that is only backed by government decree.

Many people have lost their life savings when this occurs if they have not applied effective wealth management techniques to their portfolio. It is a very turbulent time.

Final Thoughts
These concepts can be unsettling, but they need to be understood if you want to take charge of your personal financial planning techniques and Wealth Management.

Also, critical thinking, problem solving and decision making are important skills needed to make good financial decisions.

If you need assistance in these areas please see the sister site that was created to help strengthen these skills.
It is called:

Problem Solving Techniques.

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