FGV-SP Administração 2013/1

MONEY

1 Money is perhaps the most basic building-block in economics. It helps states collect taxes to fund public goods. It allows producers to specialise and reap gains from trade. It is clear what it does, but its origins are a mystery. Some argue that money has its roots in the power of the state. Others claim the origin of money is a purely private matter: it would exist even if governments did not. This debate is long-running but it informs some of the most pressing monetary questions of today.

2 Money fulfils three main functions. First, it must be a medium of exchange, easily traded for goods and services. Second, it must be a store of value, so that it can be saved and used for consumption in the future. Third, it must be a unit of account, a useful measuring-stick. Lots of things can do these jobs. Tea, salt and cattle have all been used as money. In Britain’s prisons, inmates currently favour shower-gel capsules or rosary beads.

3 The use of money stretches back millennia. Electrum, an alloy of gold and silver, was used to make coins in Lydia (now western Turkey) in around 650BC. The first paper money circulated in China in around 1000AD. The Aztecs used cocoa beans as cash until the 12th century. The puzzle is how people agreed what to use.

4 Karl Menger, an Austrian economist, set out one school of thought as long ago as 1892. In his version of events, the monetisation of an economy starts when agricultural communities move away from subsistence farming and start to specialise. This brings efficiency gains but means that trade with others becomes necessary. The problem is that operating markets on the basis of barter * is a pain: you have to scout around looking for the rare person who wants what you have and has what you want.

5 Money evolves to reduce barter costs, with some things working better than others. The commodity used as money should not lose value when it is bought and sold. So clothing is a bad money, since no one places the same value on second-hand clothes as new ones. Instead, something that is portable, durable (fruit and vegetables are out) and divisible into smaller pieces is needed. Menger called this property “saleableness”. Spices and shells are highly saleable, explaining their use as money. Government plays no role here. The origin of money is a market-led response to barter costs, in which the best money is that which minimises the costs of trade. Menger’s is a good description of how informal monies, such as those used by prisoners, originate.

6 But the story just doesn’t match the facts in most monetary economies, according to a 1998 paper by Charles Goodhart of the London School of Economics. Take the widespread use of precious metals as money. A Mengerian would say that this happens because metals are durable, divisible and portable: that makes them an ideal medium of exchange. But it is incredibly hard to value raw metals, Goodhart argued, so the cost of using them in trade is high. It is much easier to assess the value of a bag of salt or a cow than a lump of metal. Raw metals fail Menger’s own saleableness test.

* The exchange of goods and services for othr goods and services.

Adapted from The Economist, August 18, 2012