The value of money

The value of money

1.  What is Money?

Despite the fact that we are handling money every day, if we ask people, very few of them would be able to describe it properly. When we hear the word “money” what we have in mind it might go from pleasure to pain. It might be an amazing car, the house of our dreams or an endless vacation in a paradisiacal beach surrounded by Daiquiris. On the other side, it can also be seen as greedy, materialistic, and in many times as the cause of the wars, invasions, etc.

What we certainly know is that money is an asset that can be used to purchase goods or services.

I.  Brief history of money. From barter to coin

The history of barter is as old as that of man himself. An interesting fact is that it has persisted through time and even today, it is still used in some exceptional cases, especially in large-scale international agreements between the Eastern and Western blocs. This is due in large part to its adaptability and continuous improvement. As the extent and complexity of trade increased, barter systems grew naturally to suit their demands.

However, the complexity of the economy found the barter to be too complicated when finding a “double coincidence of wants”, since two parties could only trade when each wants what the other has to offer (Krugman and Wells, 2004). Therefore, a long list of crossed prices were produced: If Peter exchanged apples for corn with Josh and Josh exchanged some apples for wood with Stan, how much corn should Peter offer for a piece of wood?.

At this point, money offered a system to facilitate exchanges. In some way, money has been in use for thousands of years. For most of that period, people used commodity money. At first, it was an object that many people accepted, allowing

the exchange between more types of goods. In this case, a butcher could buy vegetables without having to find a farmer. In addition, it also fixes the prices of all goods and services and as a deposit of value, facilitating the transfer of resources between different regions and times (Farràs and Morron Salmeron, 2018).

Whale teeth, seashells, cigars and even slaves served as money, a system that above all, required trust in others. Finally, the object that stood for good was the coin,

made of gold or silver and that had an intrinsic value, the metal itself. It was durable, small, and easy to transport. However, there was a main issue: the coexistence of so many different currencies and the dubious quality of the metal they were made of.

2. Who controls money?

In 1609, the Bank of Amsterdam was created in Netherlands in order to carry out the exchanges and transactions, but also to check their quality. Furthermore, by linking the transactions to accounting books, the bank created a new form of money which was no longer embodied in a physical object.

I.  The government takes control: the creation of central banks

Since many other cities followed the example of Bank of Amsterdam, the states created the National Banks which will later control the issuance of money, helping to eliminate the diversity of coins in circulation. With the end of intrinsic money, the world switched to a monetary system based on fiat money, the money of today, which supports itself (not gold or silver). Of course, this system requires trust in the state, in the banks, and in the future… something we have seen disappearing from time to time during history, but also in many countries nowadays (Currently situation in Argentina).

II.  Commodity money

A commodity is a physical item that is interchangeable with another item of the same type or of the same value. Commodity money is a commodity that has intrinsic value (meaning that the commodity has value even if it’s not used as money). In times of need, for example in severe economic crisis, hyperinflation… we might turn to commodity money instead of the money authorized by the government. As we could see before, commodity money was used through history and it is still uses in some cases nowadays.

III.  Fiat money

Right now, our economic system is based on fiat money, coins or papers that doesn’t have any intrinsic value and that only becomes valuable when government establishes it. It must be responsibly weighted in order to control the monetary supply. This asset should work if people accepts it and trust the government for its value.

Next, we will analyse two cases through Germany’s history where money was out of control and the differences and similarities between them: The first case is an analysis of the great depression after the WWI, its causes as well as its consequences for the economy, and the solution implemented to amend the situation. The second case is based in the WWII, when, the inflation did not reach such a high level, but still, people started distrusting the system and appealed to the commodity money rejecting the official currency of the country.

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The depreciation of the mark of this period of time, was a hostile episode for the country that has had harsh effects for the Germany economy. It destroyed the wealth of the country, its moral and it unleashed to drastic political events, as Hitler’s rise to power.  

The period of hyperinflation in the Weimar Republic between 1921 and 1923 unleashed a vast series of economic consequences: rising of prices, increase of the interest rate, changes in the exchange rate and rejection of the official currency as an exchange unit, which led to the use of the antique bartering and to the use of the commodity money for a short period of time. It all started in 1914, with the outbreak of the First World War when the Germans increased the money supply to cover the increasing costs first, of the war itself, and after in order to fulfil the conditions that the Allies imposed to Germany in the Treaty of Versailles. At the same time, the link between the mark and the price of gold was cut, causing a gap between the value of the gold-based currency and the paper currency, which was being printed in almost unlimited quantities.

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1. Solutions. Monetary policy reform.

In October 1923, the price index increased 29.535% and the money supply 14.113%. Because of the increase in prices was faster than that of the nominal supply, there was a constant reduction of liquidity. To cover this reduction, economic policy decided to increase even more the money supply, which ended up by sinking the country’s economy.

1923 was a year that went through economic, political a social chaos. With the French military occupation of the Ruhr area, the uncontrolled monetary issue, the destruction of the currency and hyperinflation, the cessation of economy activity, the falls in production, the rising unemployment, the lack of food and the poverty of the population, Weimar Republic has hit bottom.  

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