October 27, 2019

The Origin of Money

Top View Photography of People by Johannes Rapprich.

At some point in time, have you ever thought about why money exists? Have you asked, why use money, why not use leaves, rocks, or other things as medium of exchange – why did we choose money? Where is the value of money coming from? It’s just a paper bill and metal coin, why does it have a value (it’s also digital today; you can’t even hold it, just like air)? Why do we believe that it has value? These are some of the questions I hope to answer in this article.

According to Adam Smith (father of economics), the first wealth of the world was purchased by labour (not by gold, by money or etc.). If you want a house, you have to build it by yourself, you have to labour (work) on your own; you have to source the materials by yourself, plan by yourself, dig and build by yourself. During those days you have to work on your own to build your wealth. Today, if you have money, you can pay labourers (carpenter, mason, engineer, architect, and the likes) to build your house, you can also buy the materials of your house using money.

Barter became a common way of exchange in the past, it’s like you can exchange something you own so that you can get something you need or want in return. If you are a carpenter, you can exchange your carpentry skill for rice grains that was harvested by the farmer. You can barter with the farmer saying that you will do the carpentry of his house in exchange for 10kg of rice grain per days of labour. If you are a hog raiser, you can exchange a kilo of pork meat to a kilo of bread baked by the baker. Thus, you would see that barter involves no currency; barter is an exchange of goods to goods, service to goods, and service to service (goods means products, items, or possessions).

But what if you have one live cow in your possession and you just want to have 1 gram of salt? It would be irrational to slaughter the cow and portion it just for a one gram of salt, or to trade the whole cow for kilos of salt. Monetary (money) system was introduced to solve this problem. There were plenty of monetary measures that were introduced in the past, but the most popular was the use of metals: gold and silver. The reason why metals were used during those times is because these metals are not easy to produce and replicate; a lot of physical labour is required to extract these metals underground. In short, these metals are not easy to get or to counterfeit during that time, which is why they were used as measurement of value (but today there are machines that can be use to ease the extraction of these metals; there are also machines, today, for counterfeiting these metals). 

Simulating the past, green leaves are easy to obtain, I will not trade my harvested fruits for leaves. Rocks are easy to obtain, I will not provide my carpentry skills in exchange for a rock. You see, people will only trade their possession (services and goods) to something that has been laboured. Obtaining rock and leaf requires very little labour at all, while digging gold and silver requires huge amount of labour. In passing, money became light weight for convenience of exchange and ease of carrying; number system was introduced to ease valuation; paper and coin money was created with security marks to prevent counterfeiting. Small metal coins and light weight paper bills became the new money which replaced gold and silver to ease the monetary transactions and exchange.

You might asked, why did we trade the precious metals to small coins and paper bills? Is it not evident that the production of precious metals is more labour intensive than the automated production of small coins and paper bills? We trade the possession of precious metals to coins and paper bills because the government guaranteed that these coins and bills have value. Thus, our trust to the words of the government is the main reason why coins and paper bills have value. The government is saying to the public that we must trust that the money that they produced or manufactured (the currency) has value, and therefore there is always someone willing to labour in exchange for the said currency. Counter intuitively, if you don’t trust the government you will not trade your possession in exchange of the currency (the money). If an ordinary man guaranteed the value of the paper bills, I will not be surprised if no one will use that currency, since trust is difficult to give to a person who has no credibility. At some point in time, the government has proven its credibility by building infrastructure, fostering independence, providing protection and security, imposing laws to maintain peace and order, and facilitating government services. That is why the people have put its trust in the government by using the currency in exchange of precious metals. It is also noteworthy to mention that the value of money is not only base on trust, but also on the quantity of labour it can command. If no one is willing to provide labour in exchange of the money, then money will no longer be valuable. The trust in the government and the existence of labour force is the main reason why money has value. 

Labour force today is no longer confined to human labour, machine can also provide labour. For example, washing machine can provide labour by washing your clothes powered by the electricity. Production machinery can provide labour by automated production of things such as cell phone, laptop, electric fan, bags, shirts, air conditioner, televisions, cars, and many others. Even your smart phone is labouring for you, it is keeping you connected to the world, to information, and to people you love; but this device requires electricity, and the use of electricity requires you to pay money. Your car will labour for you, it will bring you to different destinations, but it will require fuel energy, and obtaining fuel energy requires you to pay money. The use of money is to free us from labour, you pay for a car so that you will no longer need to engage in physical walk; you pay for a house so that you will no longer need to build it by yourself; you pay for a restaurant so that you will no longer need cook the food by yourself; you pay for food so that you would no longer need to hunt for food. People are labouring (working), to obtain money, so that they can free themselves from other forms of labour. As long as there are people and machineries that are labouring (working) and trust in the government remains high, money will continue to be valuable. 

Central Bank is the branch of government that deals with the manufacturing of money. You might ask again, since it is easy to create money by just printing it, why not print trillions of money? Then distribute the money to everyone so that the problem in poverty would be resolve, so that everyone could be wealthy? If you print trillions of money without basis, you will devaluate the money (money will lose its value). As mentioned in the previous paragraphs, the basis of the value of money is labour, thus, printed money that has no equivalent labour has no value. It means that each money in the circulation must have an equivalent labour; giving free manufactured money to someone will be unfair to people who are labouring to obtain hard earned money; giving free money will trigger mistrust to the government (people who are labouring will feel betrayed) and will result to loose of trust in the currency. 

To make the case of devaluation simple, imagine that your neighbour is labouring eight hours a day just to plant rice so that he can earn a good sum of money at the end of the month; while you, on one hand, have been authorized by the Central Bank to print money. You used your printed money to buy your neighbours’ harvested rice grains; your neighbour did not complain since the money he received as payment is authentic. Your neighbour heard the sound of your printing machine; as a result, he discovered that you are manufacturing paper bills. Do you think next time you buy rice grains to your neighbour; would he still exchange his goods for your money? 

Even if you try to convince your neighbour that the printing machine that you are using is the same as the Central Bank and that you are authorized by the Central Bank, your neighbour will start to lose trust in your printed money since he knows that you are just printing it, rather than labouring for it (Why would I trade my goods and services in a money that was just easily printed? I know that he is just sitting all day waiting for his money to be printed). You see, people are accepting money in good faith that it is being laboured. If you print free money and give it to everyone, people will soon discover that some of the money in the circulation has no equivalent labour and soon it will lose its value and confidence. This is the main reason why Central Bank cannot just print money and flood it to the circulation; Central Bank must balance the supply of money to protect the value of money. 

The value of money is just as good as to how much labour it can command; money will not resolve poverty if it has no value.

No comments:

Post a Comment

Subscribe to Philippine Economist via Email