The History of Money: From Barter to Modern Payments Systems

The history of money is a fascinating subject that spans thousands of years, starting from the simple barter system of ancient Mesopotamia to the payment systems of today.

In this article, we look at the evolution of money, focusing on its various forms and systems, the theories behind its development, and its impact on societies throughout time.

We will also discuss the implications of this history for today’s investment portfolios, including what some view as the importance of holding hard currency to protect against currency devaluation and low real interest rates.

Money with Intrinsic Value (Commodity Money)

The earliest form of money was commodity money, which consisted of goods that had intrinsic value, such as livestock, plant products, and metals of various forms.

These items were used as a medium of exchange in ancient Mesopotamia, where the barter system was prevalent.

Trading goods directly for other goods, however, presented challenges such as the lack of a standardized unit of account and the difficulty in determining fair exchange rates between disparate items.

Representative Money

To address these challenges, representative money emerged as a more sophisticated form of currency.

It consisted of tokens or certificates that were legally exchangeable for something with intrinsic value, such as gold or silver.

This development allowed for the creation of standardized units of account and facilitated more efficient trade.

Fiat Money

Fiat money represents the latest stage in the evolution of currency systems.

Unlike commodity or representative money, fiat money has no intrinsic value and is only backed by the issuing government’s promise to accept it as payment for taxes and other obligations.

The widespread adoption of fiat money allowed for greater control over the money supply, helping to manage inflation and stabilize economies.

Early Theories of Money

The development of money has been the subject of much debate among philosophers and economists throughout history.

Two of the most prominent theories come from ancient Greek philosophers Aristotle and Plato.

Aristotle believed that money was a human invention, designed to facilitate trade and store value. (This is in line with how money is considered today.)

Plato, on the other hand, considered money as a social convention that could be easily corrupted and lead to economic inequality.

Assaying and Money Formation

The process of assaying, or determining the purity and weight of precious metals, played an important role in the formation of money.

It allowed for the creation of standardized coins, which made trade more efficient and reliable.

This development led to the establishment of mints and the emergence of regulated currencies.

Bronze Age: Commodity Money, Credit, and Debt

During the Bronze Age, various forms of commodity money were used, including grain, livestock, and metal ingots.

The emergence of credit and debt systems also played a significant role in the economic landscape of this period, as people began to rely on written agreements to facilitate trade and settle debts.

1000 BC – 400 AD: First Coins and the Roman Banking System

The first known coins were introduced around 1000 BC in ancient Lydia, modern-day Turkey.

These coins were made of a natural gold-silver alloy called electrum and featured standardized weights and designs.

The Roman Empire later adopted coinage, leading to the development of a sophisticated banking system that facilitated trade and economic growth throughout the empire.

400–1450: Medieval Coins, Moneys of Account, and More

The Middle Ages saw the continued use of coins as well as the introduction of money of account, which were abstract units of value used for bookkeeping purposes.

The first paper money was developed in China during the Tang Dynasty (618-907 AD), and trade bills of exchange became prevalent in Europe.

The Islamic Golden Age, Indian subcontinent, and tally sticks also played significant roles in the evolution of money during this period.

1450–1944: Goldsmith Bankers and the First European Banknotes

In the 17th century, goldsmith bankers emerged in Europe, accepting deposits of gold and issuing paper receipts that could be used as money.

These banknotes became the first European paper currency, paving the way for modern banking systems.

Additionally, the establishment of central banks (starting with Sweden in 1668) and the transition from bimetallism to the gold standard helped to further stabilize and standardize currency systems.

1944-1971: The Bretton Woods System

Toward the closing stages of World War II, the Bretton Woods system was established to create a stable international monetary order.

Under this system, the US dollar was pegged to gold, and other major currencies were pegged to the dollar.

This arrangement facilitated international trade and investment, and provided a degree of stability to the global economy until the collapse of the system in 1971.

1971 – Present: Credit and Debit Cards, Digital Currency, and Cryptocurrencies

In the post-Bretton Woods era, the world has witnessed rapid advancements in payment technologies, such as credit and debit cards, digital currency, and cryptocurrencies.

Credit and debit cards have become commonplace, providing convenience and security for both consumers and businesses.

Digital currencies, such as central bank digital currencies (CBDCs), have begun to emerge, offering new possibilities for monetary policy and financial inclusion.

The rise of cryptocurrencies, like Bitcoin, has introduced decentralized, peer-to-peer payment systems that operate independently of traditional banks and governments.

3 Main Types of Monetary Systems Observed Throughout History

The evolution of monetary systems is a complex and multidimensional process.

Here is a general sequence of how these systems evolve over time:

Type 1: Commodity Money (Hard Money)

This is the initial phase where the economy operates on a commodity money standard, such as gold, silver, or any other tangible asset.

People directly exchange goods and services for these assets because they have intrinsic value.

This is often referred to as a “hard money” system, and it typically involves little to no debt.

Type 2: Representative Money

As economies grow and trade increases, carrying large quantities of gold or other commodities to transact in becomes inconvenient and risky.

This leads to the development of representative money.

Banks or governments issue paper notes (or coins) that are backed by, and can be exchanged for, a fixed amount of a commodity (like gold) stored in a central location.

This system is more efficient and still maintains a tangible link to the hard money.

Type 3: Fiat Money

Eventually, the demand for money and credit may surpass the amount of the commodity that backs the currency.

This could happen due to:

• too many obligations relative to the stock of hard money available, or
• the desire for increased flexibility in monetary policy

In response, governments may decide to sever the link between money and the underlying commodity, creating what is known as fiat money.

This was the case when the US unilaterally took the dollar off the gold standard on August 15, 1971 and also before that on April 20, 1933 during the Great Depression.

Fiat money has no intrinsic value, but is given value by government decree.

In this system, the government has more control over the money supply, which can be beneficial in managing the economy.

However, it also requires a significant amount of trust in the government, since the value of the money depends on the government’s ability to maintain economic stability.

This is the system most of the world is currently on and generally the most desired because of the flexibility it creates.

Debt Accumulation and Crisis

In a fiat money system, governments and private actors can accumulate significant amounts of debt.

This debt can be sustainable as long as the economy continues to grow such that the growing debt pile can be serviced, and as long as lenders maintain confidence in the borrowers’ ability to repay.

However, if debt levels become too high, such that there’s a supply/demand issue, the trade-offs become:

• higher inflation (from the central banks buying the debt to keep interest rates artificially low) or
• raising interest rates to maintain healthy supply/demand dynamics, which hurts the economy

Deficits can be funded with debt and done so responsibly when there is demand for this debt.

However, when there is excess supply, it can create a dangerous dynamic where the central bank is either forced to buy the debt that’s not wanted by the free market or let interest rates rise, which creates bad economic conditions.

Naturally, it’s a contentious political issue and can create brinksmanship where politicians threaten to not allow the issuance of more debt, which could result in a technical default.

In the US, this issue is called the “debt ceiling.”

Return to Hard Backing

Following a crisis, there may be calls to return to a hard money system or some form of representative money to restore confidence and stability.

This is not always possible or practical, however, and the process may involve significant economic adjustment and hardship.

We eventually get forced budget controls one way or another.

However, it’s not politically popular to make structural reforms even when the path is clearly unsustainable. Nobody likes being taxed more or having spending cuts.

Overall

This cycle described above is not inevitable, as a select few countries have avoided debt crises throughout their history.

And different economies may experience these stages in different ways.

Additionally, the evolution of monetary systems is influenced by a wide range of factors, including:

• taxing and spending policies
• political dynamics
• technology
• international relations, and
• cultural attitudes toward debt and credit

A Closer Look at the History of Money Since 1850

As we covered in our article on the last 500 years of financial history, large-scale currency devaluations have typically occurred in a dramatic, episodic manner rather than evolving gradually and tend to catch many by surprise.

Over the past 170+ years, there have been six significant devaluations of major currencies, though minor currencies have seen many more.

1860s-1890s

In the 1860s, the financial pressures of the Civil War led the United States to temporarily abandon the gold standard, issuing paper money known as “greenbacks” to finance the war effort.

The gold standard was reinstated in the mid-1870s, with numerous other countries following suit.

Exceptions included Japan, which remained tied to silver until the 1890s, resulting in devaluation against gold as silver prices dropped, and Italy and Spain, which frequently suspended convertibility to manage large fiscal deficits.

World War I

World War I prompted enormous deficit spending, financed by central banks printing and lending money.

In the absence of international credit due to lack of trust, gold served as the global currency.

Post-war, a new monetary system was established, with gold and the currencies of the winners at its core.

1919-22

However, between 1919-22, continued money printing and devaluations were necessary to address the debt crises of the most indebted countries, particularly those defeated in World War I.

This led to the obliteration of the German mark and mark debt in 1920-23, and significant devaluations in other nations’ currencies.

1920s

Once debt restructuring was complete domestically and internationally, the 1920s saw a period of economic boom and bubble, which ultimately burst in 1929.

1930-1945

From 1930-45, central banks had to print more money and devalue currencies first due to the debt bubble burst, and then to fund war expenses.

In 1944-45, a new monetary system linking the dollar to gold and other currencies to the dollar was established.

1946-1960s

The currencies and debts of Germany, Japan, Italy, and China, among others, were rapidly and entirely eradicated, while those of most war victors depreciated more gradually yet significantly.

Around this time, the British pound lost its status as the world’s top reserve currency to the United States following the Suez Canal crisis in 1956-57. Britain was already heavily indebted from fighting two world wars in the past 40 years.

What caused the Suez Crisis and what happened to the British pound?

The Suez Crisis in 1956 was triggered when Egyptian President Gamal Abdel Nasser nationalized the Suez Canal, a vital trade route that was mainly controlled by Britain and France.

The nationalization posed a direct threat to the maritime trade and oil transportation of Western nations, especially Britain, leading to a military intervention by Britain, France, and Israel.

However, the invasion was met with global criticism, including from the US and USSR. The political failure forced Britain to retreat, revealing its diminishing global influence.

The crisis led to a run on the British pound as investors lost confidence in Britain’s global standing and economic stability.

This was further exacerbated by the US refusing to provide financial support unless Britain withdrew from Suez, putting immense pressure on Britain’s foreign reserves (a form of national savings).

The financial crisis that ensued made evident the dependence of Britain’s economy on the US, marking a further shift in global power dynamics.

1968-73

During 1968-73, particularly in 1971, the United States’ excessive spending and debt creation from spending on foreign wars and domestic social programs necessitated severing the link with gold.

This was because demands for gold exceeded available supplies, prompting a transition to a dollar-based fiat monetary system.

This transition enabled the expansion of dollar-denominated money and credit, sparking inflation in the 1970s and leading to the early-1980s debt crisis.

2000-Present

Since 2000, the value of money has diminished compared to gold due to extensive money and credit creation, coupled with low interest rates relative to inflation.

As the monetary system is now free-floating, devaluations have been more gradual and continuous rather than hard breaks.

Low or even negative interest rates combined with strong fiscal policy stimulation following the pandemic led to a surge in money and credit and subsequent inflation.

Implications for Today’s Portfolios

The history of money offers insights for today’s traders/investors.

As financial and currency systems evolve, it is helpful to maintain a diversified investment portfolio that, for many, may be useful to include some form of hard currency, whether it’s gold, silver, and/or other commodities or stores of value that are less growth-sensitive.

This can provide a hedge against currency devaluation and protect against low real interest rates, which can erode the purchasing power of fiat currency over time.

By understanding the lessons of the past, traders and investors can better prepare for the choices they will have to make in the future.