December 3, 2008

Money: Part 1

Money is really a simple topic, but the concept has been so corrupted over time that I anticipate this will take multiple posts to discuss. Hence, the Part 1 in the title.
In order to understand what money is, we have to look at its origins. Money was originally a commodity itself. That is, it had intrinsic value because it cost somebody something to produce. For instance, if two farmers used wheat as a medium of exchange, each knew how much work, resources, and time it took to produce one bushel of wheat. They knew likewise how much work, resources, and time it took to produce one gallon of milk. They could therefore decide what benefit, in terms of wheat, one gallon of milk had in order to determine a rate of exchange (price). But they had to denominate the benefit in terms of a real commodity, something that costs to produce, otherwise they wouldn't know the "price" of the good.
Eventually, large groups of people started using precious metals as a means of trade. This was because the metals didn't lose their value due to time or environmental conditions so they could be readily circulated and widely accepted. In addition, metals could be verified by a simple system of weight measurement. The most important thing to remember here though is that precious metals did not simply grow on trees. They took work and time and resources to mine and refine. Thus, the miners could measure their production in terms of gold mined and refined in a day and how much of that they were willing to exchange for the goods and services they required.
The fundamental and original concept that money itself must be a commodity has been all but lost in today's economy. However, because of our historic use of precious metals as money and denomination of those metals in terms of our currency ($$$), we are able to operate with a system of prices. That is to say, without the basis of money as a commodity, we would never know how much something costs in terms of dollars, because dollars are not themselves a commodity and cost virtually nothing to produce.
This concept is vital in understanding the challenges in our current monetary system. Along with a basic understanding of supply and demand, it logically leads to some important conclusions that I will discuss later. However, I would like to first propose this theory of money and ask: What am I missing? Is there anything in my explanation that needs to be modified?

1 comment:

Royal said...

I'm having diffuculty finding holes in the argument, "money must originate as a commodity." If this were not the case it seems to be impossible to attach a value to the new money or denominate prices in the new money because it's relative value is unknown. A flaw may exist in the definition of commodity but this would be a mere semantical flaw and inconsequential of the main argument.
Obviously money does not have to stay attached to a commodity but can break free once it is generally accepted in trade.