From the history of money

The history of money consists of three phases: commodity money, in which actual valuable objects are bartered; then representative money, in which paper notes (often called 'certificates') are used to represent real commodities stored elsewhere; and finally fiat money, in which paper notes are backed only by use of' "lawful force and legal tender laws" of the government, in particular by its acceptability for payments of debts to the government (usually taxes).

Text 1. Commodity money is money whose value comes from a commodity out of which it is made. It is objects that have value in themselves as well as for use as money. Examples of commodities that have been used as mediums of exchange include gold, silver, copper, salt, peppercorns, large stones, decorated belts, shells, alcohol, cigarettes, cannabis, candy, barley etc.

Commodity money is to be distinguished from representative money which is a certificate or token which can be exchanged for the underlying commodity. A key feature of commodity money is that the value is directly perceived by the users of this money, who recognize the utility or beauty of the tokens as they would recognize the goods themselves. That is, the effect of holding a token for a barrel of oil must be the same economically as actually having the barrel at hand. This thinking guides the modern commodity markets, although they use a sophisticated range of financial instruments that are more than one-to-one representations of units of a given type of commodity.

Commodities often come into being in situations where other forms of money are not available or not trusted. Various commodities were used in pre-Revolutionary America including wampum, maize, iron nails, beaver pelts, and tobacco. In post-war Germany, cigarettes became used as a form of commodity money in some areas. Cigarettes are still used as a form of commodity money in U.S. prisons

The use of barter like methods using commodity money may date back to at least 100,000 years ago. Trading in red ochre is attested in Swaziland, shell jewellery in the form of strung beads also dates back to this period, and had the basic attributes needed of commodity money. To organize production and to distribute goods and services among their populations, before market economies existed, people relied on tradition, top-down command, or community cooperation.

Although some commodity money, has been used historically in relations of trade and barter, it can be inconvenient to use as a medium of exchange or a standard of deferred payment due to transport and storage concerns, and eventual rancidity. Commodity money is inconvenient to store and transport. It also does not allow the government to control or regulate the flow of commerce within their dominion with the same ease that a standardized currency does. As such, commodity money gave way to representative money, and gold and other specie were retained as its backing.

Text 2. Representative money refers to money that consists of token coins, other physical tokens such as certificates, and even non-physical "digital certificates" (authenticated digital transactions) that can be reliably exchanged for a fixed quantity of a commodity such as gold, silver or potentially water, oil or food. A key feature of representative money is that its value is very directly perceived by the users of this money, who recognize the utility or appeal of the tokens as they would recognize the goods themselves. That is, the effect of holding a token for a barrel of oil must be (to the holder) the same both emotionally and economically as actually having the barrel at hand.

Representative money is widely believed to have originated in ancient Sumer where small baked clay tokens in the shape of sheep or goats were used to replace barter in trade. Later during the crusades, representative banking notes were established by the Knights of the Temple of Solomon (the Templar Knights), so that pilgrims could protect themselves from robbery along the pilgrimage to the holy lands. Pilgrims would deposit an amount of gold in a Templar monastery in Europe and were given an equivalent in banking notes, then would "cash in" these notes for the amount of gold once they had arrived in the holy lands. The notes would have been worthless to any highway robbers and therefore were not taken. This banking system and the presence of paper monies has evolved into our modern banking system.

In the late 19th and early 20th century most currencies were examples of representative money in that they were based on the gold standard in which a currency could be exchanged for a fixed amount of gold, at least in theory. Gold was a common form of representative money due to its rarity, durability, divisibility, fungibility, and ease of identification. Representative money and the Gold Standard protect citizens from hyperinflation and other abuses of monetary policy.

Disadvantages of representative money

· Gold does not have an inherent value/energy, so exchange value has to be negotiated during each transaction. At times of scarcities like famine, exchange value of gold goes down drastically

· The total amount of gold has been estimated at around 142,000 tonnes. Assuming a gold price of US$1,000 per ounce, or $32,500 per kilogram, the total value of all the gold ever mined would be around $4.5 trillion. This is less than the value of circulating money in the U.S. alone, where more than $7.6 trillion is in circulation or in deposit.

· Fluctuations in the amount of gold that is mined could cause inflation if there is an increase, or deflation if there is a decrease.

Text 3. Fiat currency. Among many people who advocate for specie, such as gold, silver or a bimetallic standard, the term fiat money is often used as a pejorative term. Fiat currency has also been criticized by some for increasing the number and severity of boom-bust economic cycles, causing inflation, and allowing nations to initiate or prolong war. Most nations of the world shifted entirely to fiat money by 1976 after Bretton Woods System eventually collapsed in 1971

The terms fiat currency and fiat money relate to types of currency or money whose usefulness results not from any intrinsic value or guarantee that it can be converted into gold or another currency, but instead from a government's order (fiat) that it must be accepted as a means of payment.

In situations where the commodity is metal, typically gold or silver, a government mint will often coin money by placing a mark on the metal that serves as a guarantee of the weight and purity of the metal. In doing so, the government will often impose a fee which is known as seigniorage.The main purpose of either government money system has historically been to provide seigniorage, or money-creation profit, to governmental leaders in order to provide them with general purchasing power during emergencies, especially those leaders who are legislatively constrained and therefore unable to raise taxes in order to execute the defense commitments that are required for the survival of their states.

The role of a mint and of coin differs between commodity money and fiat money. In situations where there is a commodity money, the coin retains its value if it is melted and physically altered, while in a fiat money it does not. Usually in a fiat money the value drops if the coin is converted to metal, but in a few cases the value of metals in fiat moneys have been allowed to rise to values larger than the face value of the coin. In India, for example fiat Rupees disappeared from the market after 1997 when their content of stainless steel became larger than the fiat or face value of the coins. In the US, the metal in pennies (mostly zinc) and the metal in nickels (mostly copper) in both cases is now worth more than the fiat face value of the coin.

The S'ung (or Song) dynasty was the first in China to issue true paper money in 1023. Though technically not a fiat currency - as the notes were valued at a certain exchange rate for gold, silver, or silk - in practice convertibility was never allowed. The notes were initially to be redeemed after three year's service, to be replaced by new notes for a 3% service charge, but, as more of them were printed without notes being retired, inflation became evident and the notes fell out of favour.

World War I set the stage for a collision between specie currency and fiat money. By this point most nations had a legalized government monopoly on bank notes and the legal tender status thereof. In theory, governments still promised to redeem notes in specie on demand. However, the costs of the war and the massive expansion afterward made governments suspend redemption in specie. Since there was no direct penalty for doing so, governments were not responsible for the economic consequences of “running the printing presses”, and the 20th century found itself facing a new economic terror: hyperinflation.

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