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Play this video to have Danny read this lesson to you…
Other questions answered in this lesson:
- What does barter mean?
- What is a commodity?
- What is fiat money?
Prerequisites:
- None.
Corequisites:
Advanced topics to tackle next:
- What is inflation?
- What is money supply?
- What is fractional reserve banking?
Let's get to the lesson…
Money is anything widely accepted as payment.
Money serves as:
- a medium of exchange,
- a unit of account, and
- a store of value.
We’ll talk about each of those in more detail later, but first, let’s talk about…
The Origins of Money
The earliest forms of money emerged from the barter system, where goods and services were exchanged directly. Imagine you’ve got a cow and I’ve got some wheat. I want a cow and you want some wheat. We decide how much wheat is worth a cow and we trade the cow and wheat. This is how we traded goods and services for a long time.
Bartering worked for simple exchanges but had limitations: it required a “double coincidence of wants” (you have what I need, and I have what you need).
Around 6,000 years ago, Mesopotamian tribes began using agricultural symbols on clay tablets to represent debts, marking the first known use of symbolic value rather than physical exchange.
Evolution of Money
- Commodity Money: The first step past bartering into using money is commodity money.
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But first: what is a commodity? A commodity is a basic good or raw material that is interchangeable with others of the same type and traded on markets, such as oil, gold, or wheat.
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Early societies used commodities like cattle, grain, and precious metals as money. The use of gold and silver bars and even bits of wire began around 4,500 years ago in Mesopotamia and Egypt.
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For instance, in ancient Mesopotamia, barley was used as a standard unit, while in the Americas, cacao beans functioned similarly.
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This shift marked money's role in enabling indirect exchange and simplifying trade.
– - Coinage: The first true standardized coins were minted in the Kingdom of Lydia (modern-day Turkey) in the 7th century BC – about 2700 years ago – using electrum (a gold-silver alloy), stamped with royal seals to guarantee weight and purity.
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Greek and Roman civilizations adopted and expanded coinage, making money a central part of daily transactions.
– - Paper Money: China developed paper currency during the Tang Dynasty (618–907 CE) – about 1200 to 1300 years ago.
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This revolutionized trade by allowing value to be carried in a lightweight form.
– - Banking: Medieval banking systems led to the issuance of paper money backed by gold or silver.
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The gold standard, adopted by England in 1816 and the U.S. in 1900, tied currency value to gold reserves.
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Europe adopted similar systems in the 17th century with banks issuing receipts for gold deposits, leading to fractional reserve banking.
– - Fiat Money: By the 1970s, most countries moved to fiat money which is currency not backed by physical commodities but by government decree.
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The 20th century saw a pivotal shift to fiat money. After World War II, the Bretton Woods system pegged currencies to the U.S. dollar (itself gold-backed), but in 1971, President Nixon ended gold convertibility, making most global currencies fiat.
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This allowed governments to print money flexibly but introduced risks like inflation.
– - Digital Currency: In recent decades, technology has introduced digital payments and mobile banking, further transforming how money is created, stored, and exchanged.
Electronic banking, credit cards, and apps like Venmo represent most transactions today. Over 90% of money in developed economies is digital, existing as ledger entries.
– - Cryptocurrencies: Cryptocurrencies like Bitcoin (introduced in 2009) challenge traditional systems by offering decentralized, blockchain-based alternatives, harking back to money's origins in trust but without central authority.
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Cryptocurrencies are not yet widely used as money, but may plan a role in the future.
Modern Definition and Meaning
Today, money is defined as anything widely accepted as payment for goods and services or repayment of debts. It functions as a:
- Medium of Exchange: Facilitates transactions without barter. It eliminates barter's inefficiencies, allowing seamless transactions.
– - Unit of Account: Provides a standard measure for pricing goods, debts, and value.
– - Store of Value: Allows value to be saved and transferred over time. Holds purchasing power over time, though inflation can erode this.
What makes money valuable? Money backed by commodities is valuable because we agree that the commodities backing the certificates are valuable. Fiat money is valuable because governments back it and we trust the government to back it.
Key Characteristics of Money
- Portability: Easy to carry and transfer.
- Durability: Resists wear and decay.
- Divisibility: Can be split into smaller units.
- Uniformity: Each unit is identical in value.
- Scarcity: Limited supply helps maintain value.
Take the quiz: What is money?