Money - the root of global trade

Table of Contents

1 Introduction and Outline

2 Definition

3 Historical Overview

4 Functions of Money
4.1 Economic Monetary Functions
4.2 Secondary Monetary Function
4.3 Supplemental Functions of Money

5 Inflation and its socio-economic impact - case study

6 Current Debate about the European Common Currency

7 Conclusion

Appendix

Glossary

Bibliography

1 Introduction and Outline

The transition from barter economic systems to early monetary economies in Europe took place at around 700 BC. Ancient Greece (1000 BC – 323 BC) and afterwards the Roman Republic (509 BC – 44/27 BC) successfully established simple coinage systems^[1] with currencies like the denarius^[2] that already managed to fulfil the three modern economic functions that distinguish money from all other assets^[3].

In line with an ancient “free-market”-regulatory system during the early years of the Roman Empire (44/27 BC – 476 AD) the denarius subsequently paved the way for a tremendous enlargement of foreign trade, thus marking off the beginning of modern “free” trade.

On the other hand, the Romans were the first who suffered from the negative aspects and challenges of a market economy: since modern principles as social and income justice as well as price stability were fully disregarded, the Romans were facing financial inequality, hyperinflation^[4], and cultural erosion of their “way of living”. Their fiscal and monetary policy harshly failed to finance long-term public expenditure, in particular military expenditures and imperial bribes. This imperfect competitive system is one of the main reasons for the disastrous collapse of the (Western) Roman Empire.

However, this erroneous trend cannot only be assessed for ancient market systems: inflation during the years 1914-1923 in the German Reich and Weimar Republic also showed negative economical implications of hyperinflation including intense individual suffering and social impairment. Accompanied by the Black Tuesday of 1929 the German inflation finally fuelled political extremist fractions and amplified distrust towards economic institutions and legitimate democratic authorities.

Besides the obvious economic functions of money there are also others, which are hardly mentioned in modern economic theory: Money still has the function as intermediary between the issuer and the user. It permanently acts as latent communication device. In former times decision-makers often sent manipulative ideological messages, in particular on the versi of coins^[5]. To date this technique has been improved and expanded by psychological aspects: e.g. besides the economic aspects, the introduction of the Euro aimed essentially at internalizing an integrative concept (European Integration). In order to establish an understanding of supranational sovereignty, the design of the Euro maintains national and cultural roots under a supranational umbrella. Conclusively, the impact of an adequate currency is much greater than can be seen at the first glance by plain economic analysis – even if inflation could be fully considered financially. In fact, money can also be understood as political communication process.

To establish a thorough understanding of money and its underlying economic principles, the paper at hand aims at outlining the repercussions of money both on the economy and on society. It will provide the answer to the following research question:

Which impacts does the introduction of money have on social perception and economic prosperity?

Hence, based on a suitable definition of money a historical overview of the introduction of currency in the Roman Empire will be provided in section I. Part II looks at the economic functions of money and additionally offers supplemental functions that are not mentioned in economic theory. The following section tackles the macro-economic occurrence of inflation and its impacts on both society and the economy of a state. The next part looks at the phenomenon of European monetary integration and tries to examine the current debate from different points of view. Finally a brief summary is given to answer the above mentioned research question.

2 Definition

Although researchers provide the reader with a variety of definitions, an appropriate characterization of the term “money” is indispensable for the paper at hand to justify the outline of the following history section. According to the Encyclopaedia Britannica money is a commodity that is accepted by general consent as a medium of economic exchange in which prices and values are expressed (c.f. “Money II”). It is the set of assets^[6] that people regularly use for purchase (c.f. Mankiw 2004: 628). Money is referred to as a standard that goods and services can be substituted for and is used as admeasurement of their values on a particular market^[7] and therefore can comprise various forms: either a commodity^[8] or – predominantly – authoritatively issued coins or bank notes. In a more narrow sense money often is understood as a nation’s official currency, e.g. solely coins and negotiable paper notes issued by a government. If assets and property are considered accessorily then money additionally contains wealth and monetary value as another shade of meaning.

Furthermore, the definition of “money” also depends on a researcher’s educational background: According to Mises (Mises 1999: 29) the main focus of the economic functions of money^[9] are strongly depending on the researcher’s approach: In the common parlance money simply is a mean of payment for which everyone can receive goods in an economy. Whereas in jurisprudence money is mainly understood as a medium of payment, in economic theory money’s three-fold economic function is focused.

Another expression that needs delimitation is the term “currency”. Currency can either be understood as the money of a particular country or currency zone. It can also be used to address the material circulating portion of a nation’s money supply, which consists of banknotes and coins. Therefore, the words currency and money will be used as synonyms in the following paper as is done in the majority of academic literature.

3 Historical Overview

This section treats the historical development of money, its origin and emergence. The various theories and explanations concerning this research topic are often unproved and speculative. The most prevalent assumes the origin of money in trade^[10]: Beside others, Menger (c.f. Menger 1909: n.p) argues that money had developed from the “logic of the market”. In former times, those goods were accepted as intermediate goods that were of particular desire to humans and of high stability, transportability and divisibility as exchange medium. Accordingly, the market requirements have progressively led to a variety of certain commodities used as money^[11]. The advantages of this type of exchange paved the way for thinking in economic categories.

Laum (c.f. Laum 1924) advances a different viewpoint: His theory of “holy money” is derived from a religious, ritual context. The existence of money has to be traced back to symbolic actions such as sacrifices to gods or payments to priests. The property, which expressed the symbolic value of oblation and penalty best,^[12] was used as value measure. Hence, money was developed when high valued natural products of limited quantity were used as commodity money. These items had additional intrinsic value, far beyond their actual value of use (c.f. Mankiw 2004: 629). Commodities like cattle, shells^[13], whale teeth, feathers, stones, tobacco^[14] or metals could fulfil the functions of money. The characteristics depended on temporal and local conditions. Only while using commodity money the exchange value is directly represented in the “material” of the transaction.

The oldest coins were probably minted in China (already around 3000 BC), whereas the first coins of the ancient world were coined at about 2000 BC in the Mediterranean. Many historians assign the first widespread use of coins to Croesus, king of Lydia. Figurative illustrations on coins emerged at around 600 BC followed by gold and silver coins of different sizes and values. These values, guaranteed by the issuer did not always coincide with the real value^[15]. Devaluation of coins in the Roman Empire was intended to raise the government’s profit from money creation to cover up for its incapability to finance its expenditures by taxation. However, the debasement lead to rising prices and fierce economic situation, and therefore contributed to the breakdown of the empire^[16].

Irrespectively of counterfeiting and debasement, money was for a very long time initially bound to valuable physical assets. However, the real value of commodities used diminished over time. Nowadays, money is made out of nearly worthless materials^[17]. While a nation’s government formerly had to deposit the equivalent of the value of money in circulation in gold bullions at the central bank, the international system of gold reserve had almost been abandoned since the early nineteen-seventies. Thenceforward, it was only a little step to create “fiat money”^[18].

The question that might arise from the above is who invented money. This cannot be answered across-the-board; first, as its answer is strongly dependent on the chosen definition of money^[19] and second, because of uncertain and invalid sources.

In the next section the essential functions money had since its establishment will be discussed in somewhat greater detail.

4 Functions of Money

4.1 Economic Monetary Functions

Money is often referred to as one of the great inventions of mankind since it is responsible for complex exchange transactions and the whole possible economic life of a nation. Contrariwise, in societies where free exchange of goods or services is unknown, money is just unnecessary: If the division of labour was a solely domestic matter and production as well as consumption was achieved within the households, it would be just as worthless as it would be for an isolated individual^[20]. The existence of money requires general economic conditions where production is based on the division of labour and “in which private property consists not only of goods of the first order (consumption goods) but also in goods of higher orders (production goods)” (Mises 1980: 41). Since there is no centralized control, the adjustment between production and consumption in a Market Economy is done by the market. The function of money in this case is to facilitate market business by acting as a universal medium of exchange. Nowadays, money comprises two different elements: legal tender^[21] as well as deposit money^[22].

The following paragraph sketches the defining elements of money in economics – irrespectively of its appearance

- Medium of Exchange: Money most importantly acts as a medium of exchange and therefore offers a time span between the buying and selling process of commodities (c.f. Mankiw 2004: 629). Originally, exchange was organised on the basis of barter trade, whereas money is much more efficient, since it fulfils its function as a totally general medium of exchange. By dividing the act of barter into two elements, the usage of money avoids the problem of what is commonly known as the double coincidence of wants and needs. Without money as exchange standard people had to search for the possibility of goods-exchange for a long time because information about prospective partners, their goods and their needs had to be gathered. Additionally, estimating the value of goods has been very complicated. Consequently, money eliminates the need for an isochronical concurrence of wants implied by barter trade.

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^[1] Particularly the introduction of the Roman denarius spread sufficient trust among Romans, provincials and other Non-Romans.

^[2] Direct silver standard currency, e.g. 20 AD: 3.65 g Silver per denarius.

^[3] See Chapter 4.1.

^[4] As a result, in 301 AD Emperor Diocletian released the first harsh “state intervention” for competing markets in history: the Edict on Maximum Prices.

^[5] E.g. the sesterce of Emperor Nero: financial and agricultural donations to the public.

^[6] “Any asset can be used as money, provided it is accepted as such by the power of convention or general agreement and positive experience and provided that people have trust in its value and its stability.” (ÖNB n.d: n.p.)

^[7] For further details: section 4.1 “The Economic Functions of Money”.

^[8] Such as gold, cigarettes or investment property for example.

^[9] (those will be discussed in course of this paper)

^[10] e.g. Menger, Mises and many more

^[11] At any time a direct exchange seems to be not feasible, each trader would try to exchange the less required commodities for the most marketable ones.

^[12] E.g. cattle in the archaic Greece.

^[13] Especially the well known cauri-snails in China (1500 BC – 200 AC).

^[14] Cigarettes were temporarily used as replacement of money in Germany after WWII.

^[15] E.g. shortly after the silver denarius was introduced around 212 BC, the previous “aes” began to be corrupted to a decrease in weight from about 450 grams to only 15 grams While the amount of alloy was increased up to 3/4 or more of its weight, the metal content of all gold and silver coins was reduced. (cf. “Nobel” n.d: n.p)

^[16] This economic phenomenon will be discussed in a later section of this paper.

^[17] i.e. notes of paper, metal of very little value

^[18] That is a currency that has insignificant intrinsic value and is not backed by any commodity but used as money because of government decree (c.f. Mankiw 2004: 630).

^[19] Some researchers claim that money was developed in the civilisations of the Near East (Mesopotamia, Egypt, Syria, and Palestine) in the three millennia prior to the Greek Classical Period. However, no coin was ever minted in the Near East in those days.

^[20] e.g. Robinson (c.f. Suhr n.d.: 4)

^[21] As known since the Roman Empire: banknotes and coins.

^[22] Consisting of current account deposit / electronic money etc.