Trading History

What is money? (So you don’t look silly in front of your kids)

October 4, 2019
It makes the world go round. It’s so much a part of our lives that we take it as a given. But what is money and where did it come from? In the following article we present two opposing explanations as to the origins of money.
What is money? (So you don’t look silly in front of your kids)

Albert Einstein once famously remarked that if you can’t explain it to a six-year-old, then you don’t understand it yourself. Any parent who has ever tried to explain what money is to their child has probably run into this issue almost immediately.

The more questions they invariably ask, the more you realize that you don’t actually know what you’re talking about. Try asking your friends or colleagues the same exact questions and you’ll find many of them going around in circles, doing a version of what you were doing with your kids.

It turns out that we don’t know all that much about money, after all. Other than we want it and need it, of course. Marshall McLuhan once famously remarked that we don’t know who discovered water, but we know it wasn’t a fish. This probably accounts for why money is such a strange subject for us.

It makes the world go round. It’s so much a part of our lives that we take it as a given. Much like a fish takes the water that it swims through as a given. The reason why when we try and explain it to our children, we end up giving them a version of “it’s just the way it is, dear.”

The bottom-up explanation of money

One of the most commonly cited stories that we tell ourselves about money is that it evolved naturally out of the barter economy. You’re probably already familiar with this story. You may have even told a version of the same story to your kids.

Back in the olden days, it goes, people would barter with each other, trading what they had between themselves without a currency to function as a medium of exchange.

However, the problem with exchanging goods and services is that it requires each party wants precisely what the other has to offer. So, if you have chickens and I have beans, for us to make a trade, you must want beans, and I must want chickens (good luck with that).

The problem is that with no medium of exchange, barter economies also have no unit of account, something that other things can be priced in.

Say that by some miracle of coincidence, you do want beans and I do want chickens, how do we determine how many beans a chicken is worth? Moreover, if there’s a third trader, who also wants chickens, but only has apples to trade? You see how this quickly gets messy.

What’s the problem here?

The problem apart from the fact that every seller has to simultaneously be a buyer of what the other has to sell (and vice versa), some goods are fundamentally more desirable than others.

Carl Menger, an economist who was central to the advancement of the barter theory of money, describes this quality as “salability.” In other words, some commodities are easier to sell than others.

In Menger’s view, what took place was spontaneous gravitation towards more salable commodities, not because they were valued or needed in their own right, but because they helped people get one step closer to the thing that they wanted.

Say you want to sell your chickens!

But require neither the beans nor apples that we have to offer. Now, we need those chickens, so we could sell our beans and apples for another commodity that we know you value higher than either apples or beans.

This, Menger claims, is how money gradually evolved, by traders naturally gravitating to more saleable commodities, each becoming a type of money when they became widely enough accepted.

When this happened, people naturally started thinking in terms of how much of the salable commodity their goods were worth (their purchasing power), rather than how much of the thing they actually wanted. This changed everything.

Buying and selling are difficult without a generally accepted thing in the middle, whatever it may be, that represents money. It can be commodity money like gold and silver or paper currency like we use as legal tender today. A system like this allows you to easily determine the amount of money that the thing you desire costs.

The top-down explanation of money

Proponents of the top-down theory of money claim that all of the above is just a quaint fairytale that we’ve told ourselves because it makes intuitive sense. They point to the fact that no evidence of a barter economy like the one Menger describes has ever been found in the historical record.

This camp focuses on the fact that history is littered with references to payments for things such as sacrifices to the Gods, debts, fines, and tributes. All of which suggests that money came about as a result of large public institutions, both political and religious.

Some of the earliest records we have demonstrated an intimate connection between money and violence, both in terms of sacrifice, but also as payment to victims. The code of Ur-Nammu, which is the oldest surviving code of law we have today (c. 2100–2050 BC), is full of codified cash sums to be paid to the victims of physical wrongdoing.

For example, law 19 states this:

“If a man has cut off another man’s foot, he is to pay ten shekels.” Law 22 states that: “If a man knocks out a tooth of another man, he shall pay two shekels of silver.” Law 8 states that: “If a man proceeded by force, and deflowered the virgin female slave of another man, that man must pay five shekels of silver.”

It’s conceivable that just as the bottom-up theory sees money evolving naturally to serve the needs of individual traders, it could have just as naturally have arisen as a way to quantify the obligations of one citizen to another in emerging societies.

You can imagine how fragile the balance might have been in these early societies; monetary payment may have been a way to avoid violent reprisals that could quickly degenerate into all-out war.

In ancient Mesopotamia, the Sumerians used clay tablets to keep records of ownership and debts. The oldest surviving tablet of this kind dates back to around 1650BC and records that at the time of harvest, a person named Amil-Mirra would pay 330 measures of barley to whoever held the tablet.

It’s astonishing to think that the earliest forms of writing were actually used for financial transactions and that one of the earliest forms of money was a form of debt!

In ancient Greece, the connection between sacrifice and money is there to observe in the very language itself.

Before the Greeks ever had their coinage, iron spits that were used to make sacrifices to the Gods came to be highly valued and were even used as money. The lowest value Greek coin (obol) took its name from these spits (obelos), and the word drachma initially referred to a handful of spits.

It’s difficult to imagine any of the above examples being able to exist without political and religious authorities to enforce them. It’s conceivable that money evolved as a means of creating order out of chaos.

Proponents of the top-down theory of money like to connect the dots between sacrifice being some form of primordial debt to the Gods, this gradually evolved into debt/tribute to their human representatives (kings and emperors), which finally turns into a kind of obligation to society itself.

Both are just origin myths

Both versions of this story are mostly origin myths. Just as the creationists have God creating the world out of nothing in seven days and the evolutionists have the universe bursting forth out of nothing with the big bang. The truth is that we don’t know.

The type of societies that existed in the barter economies of Menger was unlikely to leave any records of their proto-transactions, so history will have to remain silent on this issue. Also, there’s nothing to say that both theories can’t be right in their respective ways (one reality leading on to the other).

What’s important to keep in mind is that it’s almost impossible to divorce any theory from ideology. Those who hold to the bottom-up theory of money tend to be libertarians and gold bugs who believe in free markets, hard money and are against any and all government intervention.

Those who hold to the top-down theory of money tend to be much more in favour of centralized control by governments and central banks. Each group has its own historical origin story that “proves” their current beliefs and provides a justification for them.

If this article has taught you anything, it’s probably why we tell the barter version of this story to our children. It’s so much simpler! It’s also why many economics textbooks still run with it, despite all the evidence to the contrary. At least now, though, you’ll also be able to furnish your listener with the other side of the story when the subject comes up!

Disclaimer: This article is not investment advice or an investment recommendation and should not be considered as such. The information above is not an invitation to trade and it does not guarantee or predict future performance. The investor is solely responsible for the risk of their decisions. The analysis and commentary presented do not include any consideration of your personal investment objectives, financial circumstances or needs.

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Categories: Trading History

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