Four Phases in the History of Money Luis Angeles * January 2019 Abstract In this paper I offer a new characterisation of the history of money into four major phases, from the earliest written records during the 3 rd millennium BC to the present day. This characterization sheds light on both the nature and the evolution of money, and helps us to understand today’s monetary arrangements. Money evolves over time as the media of exchange in use change from metal to coinage and from coinage to different forms of debt, and as the unit of account becomes more or less linked to the value of a commodity or a physical object. * Adam Smith Business School (Economics), University of Glasgow. University Avenue, Glasgow G12 8QQ, United Kingdom. Email: [email protected] 1 1. Introduction This paper organizes the history of money into four phases or eras, from the 3 rd millennium BC to the present day. Doing so not only enhances our understanding of how money has evolved over time; it also clarifies our views about the nature of money and renders our current monetary system intelligible. Although the literature on the history of money is vast, the characterization presented here is novel and gives a unifying thread to monetary arrangements over all recorded human history. Economists typically define money as “any asset that can easily be used to purchase goods and services” (Krugman and Wells 2006, p. 722). Money is then said to fulfil several functions, notably those of serving as a medium of exchange, a unit of account, and a store of value. It is important to realize that, for the purpose of studying money’s history, the above definition is constraining. First, it assumes that, once a form of money is in circulation, both the unit of account and the medium of exchange functions are satisfied, and satisfied to the same extent. As we shall see, through most of human history this has been far from the case. Second, the definition fails to point out that most of what we refer to as money nowadays are in fact the liabilities of certain institutions – what I will call credit money . As we shall see, much of the history of money concerns the passage from forms of money which are not liabilities to forms of money which are. Given the historical scope of this paper, it will be advantageous to start not from a definition of money but from a broader concept which I shall refer to as a monetary system : A monetary system is a unit of account and a set of media of exchange. Together, these two elements enable the functioning of a market economy. It will then be pertinent to provide definitions for the two elements just mentioned: A unit of account is a quantity of economic value in terms of which we can express the economic value of all goods and services in the economy. 2 A medium of exchange is an item whose value is always equal to the unit of account (or multiples thereof), and which is convenient to use in trade and easy to store. It is accepted in all payments not for final consumption, but for the purchasing power it gives. Since media of exchange are present in everyday transactions and are often physical objects or have a physical counterpart, they are what the public commonly refers to as “money”. As we see, the definitions above change the usual perspective for understanding money. Instead of considering unit of account and medium of exchange as two functions which an item called money satisfies, we consider the unit of account and the medium of exchange as two separate kinds of items. Only the latter of these two may be a physical object. The approach describes rather well the usual practice among historians of money, who commonly refer to the unit of account and the media of exchange as separate entities. Economists, on the other hand, have not warmed up to this approach with only a few exceptions – most notably, Keynes (1930). Pity, for as I hope to demonstrate in what follows, this way to describe money is quite superior. The next four sections of this paper review the fundamental characteristics of each of the four phases of monetary evolution referred to above, each time emphasizing what serves as the unit of account, what media of exchange are available, and how societies move from one existing arrangement to the next one. Most of the historical evidence concerns Western civilization – while non-Western monetary traditions are numerous and important, it is the Western approach which eventually becomes the standard all over the world. 2. First Phase: Early Monetary Systems Adopting a unit of account brings substantial benefits to a society. A unit of account allows for the value of all items to be expressed in a common measure, and for these values to be added and 3 subtracted from each other – facilitating exchange, planning, and book-keeping. It also makes the handling of debts much more convenient, and makes possible the calculation of interest on such debts. Through most of human history, the quantity of economic value which served as the unit of account has been defined as the value of one unit of a certain commodity. Early examples are the value of a head of cattle, a bushel of grain, or a weight unit of metal – this last option eventually coming to supersede all others. The very earliest written records in human history, dating from the 3 rd millennium BC, make abundantly clear that the value of goods and services was routinely measured using as unit of account the value of barley (Mesopotamia), copper (Egypt) and silver (Mesopotamia, Egypt, and eventually the whole Near East). It is likely that the use of a unit of account predates the invention of writing in many societies – as best illustrated by William H. Furness’ classical study of money in the Pacific island of Yap (Furness 1910). Once a unit of account has been established, society has essentially two alternatives for furnishing itself with media of exchange. First and most obvious, the commodity whose unit value serves as a unit of account may itself be a medium of exchange. Whether this alternative is employed, and to what extent, depends on the physical characteristics of the commodity in question and on its availability. Indeed, in addition to having a value which is always equal to the unit of account, a medium of exchange needs to be convenient to use in trade and easy enough to store. Heads of cattle, while a valid unit of account, make a poor medium of exchange in most circumstances. Measures of grains would be a more viable choice, while metals in general, and precious metals in particular, are the best medium of exchange that nature has to offer. Clearly, the choice of the unit of account may be guided by the suitability of the underlying commodity as a medium of exchange – which explains why societies everywhere in the West eventually converge on the value of silver or gold as their unit of account. Between the 3 rd and 1 st millennium BC, silver in 4 bullion form – often cast in the shape of rings, bars, and springs – becomes a medium of exchange of universal acceptance in Western civilization. There is, however, a second alternative for supplying media of exchange to a society. A debt denominated in the unit of account satisfies the condition of having a value equal to a certain multiple of this latter one if the issuer is trustworthy (in other words, a debt of four ounces of silver is worth four ounces of silver). If such a debt is accepted as a payment for goods and services in transactions which do not involve its issuer, we may say the debt in question is being employed as a medium of exchange. To be clear, debts denominated in the unit of account are created routinely when goods or services are sold on credit or when the commodity that defines the unit of account has been borrowed. Such debts would typically not be media of exchange since the beneficiary would not be able to use them as a means of payment to a third party. If the issuer of the debt is known to be trustworthy, however, this latter operation becomes feasible – and the debt in question begins to circulate as money. We may refer to this second family of media of exchange as credit money . Credit money is very far from being a recent innovation – in fact, its origins may be traced all the way back to the 3 rd millennium BC in ancient Mesopotamia. Assyriologists have documented debt records printed on clay tablets where the beneficiary is not identified by name, the debt being payable to a tamkarum (a merchant or trader). Experts agree this formulation was intended to facilitate the transfer of the debt by making it payable to the bearer – which, in turn, makes it likely that such debts circulated as money.1 1 Veenhof (1997, p. 356). On the use of debt records as means of payment in ancient Mesopotamia see also van de Mieroop (2002, p. 166) and Radner (1999, p. 137). 5 ~~~ It is important to realize that the adoption of a unit of account and the introduction of media of exchange are separate phenomena. A unit of account may be introduced in all transactions and debt calculations at no cost once society has agreed on its value (a process in which the state is likely to play a leading role).