No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Eleven: Money, Money, Money! 254 were the most marketable commodity; what a pain it would be whenever you wanted to go to the store! Obviously markets historically dealt with this by creating money substitutes that functioned as a claim on real money. Even gold is something you may not want to carry around due to threat of robbery, and large quantities can be quite heavy. Historically, paper claims to money in a bank were circulated rather than the actual gold (certainly large amounts). Likewise, a paper claim could represent a cow or anything else. The quality of money should be easily recognizable so that “experts” aren’t required to support every market transaction. For coins, mints sprung up to ensure a consistent monetary quality. Gold itself is denser than most other metals, so it is more difficult to counterfeit. A “bite” test could be used in an exchange to verify if a coin was real gold; gold-plated lead coins (similar density to gold) would be soft enough to leave imprints of a bite. The commodity that had the best combination of these features would become the most marketable, and thus became the monetary standard. No human central direction was necessary, only the combined free choices of many market participants. While we don’t know what the ideal would be today, we know two things. First, gold and silver were the two most commonly chosen forms of money. Second, we know that no people ever freely chose a fiat standard of paper money. The evolution of money into a fiat standard was indirect, with paper money initially representing a claim on commodity money. States initially would make paper currency legal tender (where it has to be accepted in trade by law). And after a period of time, the population would become habituated to paper dollars, allowing the state to eliminate any link to a precious metal. Unfortunately, we also know a final fact—historically the value of all paper (fiat) money goes to zero. Are you curious how that compares to commodity money? You’ll see in a moment. FUNCTIONS OF MONEY Ok, now we know what a “good” money is like, but what do we want money for? Of course you say we want it to spend, but I think we can be a little more precise than that! Money fulfills four commonly understood and distinct functions. The most common is the way we use money most of the time, as a medium of exchange . Whenever we go into a store and make a purchase, we are using money to ATTRIBUTES OF MONEY: 1. Divisible 2. Durable 3. Scarce 4. Transportable Medium of exchange: the primary function of money as an institution: money is exchanged for goods in markets, eliminating the high transaction costs associated with bartering.