The desire for there to be some level of intrinsic value associated with currency gave rise to many systems of commodity based currency. It is easy to understand why commodities such as gold have been used for thousands of years as a means of facilitating transactions due to the simple requirements of money: being 1) a store of value and 2) a medium of exchange.
The origins of commodity money can be traced as far back as Babylonian and Sumerian civilizations. In those societies, grains and fruits were often used to facilitate transactions (Davies). These grains were very valuable, as civilizations during this time period were agricultural. So transactions that were facilitated by using grain as a currency were essentially insured by the value of the grains. People were able to trust in the value of this currency because grains could be consumed or used for another transaction. There were also forms of credit established during this time, but people would only trust credit transactions if they were backed by some trust worthy entity, usually a royal family (Davies). The use of grain as currency was most prominent under ancient Egypt. In fact, there were banks established that dealt solely in grain. Because grain was highly demanded in Egypt, especially by the state, there was protected value in trading with grain (Davies).
During this same time period, the Greeks had established a similar system that was based on the practice of coining precious metals (Cartwright). The Greeks are often cited as the prehistoric masters of banking and gained this reputation by taking metals such as copper, gold, and silver, and developing coins that could be used to pay debts. As is the case with commodity money, these metals had alternative uses that the state or individuals could explore if they felt the currency was being undervalued.
One of the reasons that coinage became prominent was it was an easy was for the state to pay off debts, specifically to soldiers who required some tangible amount of value for their services. Different weights and corresponding designs were established to communicate how much coins were worth. A higher weight meant more metal which thus was more valuable.
There continued to be more and more examples of societies using coinage systems as a standard medium of exchange. For example, during the same time that the Greeks were coining precious metals, the Chinese rulers at the time began coining base metals to create a standardized currency. While these metals were less valuable by nature (due to being less durable or useful in other ways), they were effective for carry out everyday purchases.
For large transactions, the state would turn to precious metals. The one problem that all coining societies faced, however, was counterfeit coins. Citizens would match the design and weight of coins with less valuable alternatives and attempt to use the fake currency as they would any other coin. Many ancient Greek coins that have been uncovered over the years have holes punched into them, which is an indication that they were testing if the coins were made up of the believed material.
While many different commodities like grain or cattle were used early on, it appears that once societies began to coin metals, they did not stop. Due to the variety of uses for metals, specifically gold, coins were trusted by citizens and became the preferred means of transactions. Coining became a common practice in many societies and was quite prominent in medieval Britain.
As population grew however, and the demand for coins increased, the precious metals used to create the individual coins became less accessible and this created a big problem for Britain. The society and citizens had adopted coin as the currency and any attempt to change to a fiat system would be met with opposition. Britain decided the best solution was to debase the currency by melting down current coin. The Great Debasement, started by Henry VII in 1544, resulted in each coin containing less of the actual precious metal and in some case. While in theory this was a good idea, as there would be more coin in circulation and thus more economic activity, the people in Britain hated the idea of carrying around coin that had less amount of intrinsic value. On top of this Britain faced a serious problem of people chipping and counterfeiting the currency by taking small pieces of actual coin and fashioning their own look alike coins. There were two ultimate effects of this on the British society. 1) Citizens lost faith in the Monarchy. They felt cheated out of the actual value of their currency because the new coins lacked the intrinsic value they looked for (“The Great Debasement”). 2) It crushed the British trade relations with other monarchies like France. The French were not interested in the debased currency and would not accept it as payment for trade (“The Great Debasement”).
This was not the first time that a civilization debased their currency due the need for more coin. One very famous example was the Roman empire. From 64 AD to 270 AD the Roman Denarius went from containing 95 per cent silver to containing almost no silver. What happened during this time, was a large scale debasement policy was enacted. “With a finite supply of silver and gold entering the empire, Roman spending was limited by the amount of denarii that could be minted” (Desjardins). This led to a problem as Roman emperors wanted to spend more money than they could on different buildings and wars. So to solve this they just cut down the purity of the coins, but made the face value the same. The only effect this had on the economy, though, was it took more coins to buy different goods and services. For example, Roman soldiers required more pay from the empire for their services.
The economy was decimated and the empire tried to force higher and higher taxes on the citizens. By the end of the 3rd century, there was no meaningful medium of exchanged left in the economy (Desjardins). All trade shifted to more local exchanges on the basis of barter, not by using the currency. Soon after, the Roman empire split into three states and in 476 AD, the Western Roman Empire would cease to exist. This is an important case and shows the fragility of a commodity based currency.
As the British empire expanded to the Americas, similar issues presented themselves due to the commodity based currency of Britain. The American colonies’ main trading partner at the time was of course Britain, and British merchants expected coins, like they would get in Britain, in exchange for their goods. As the years went on less and less coins existed in America, as it was all being used to purchase the British imports. Like Britain had experienced in years past, there was a large shortage of currency in the colonies, which forced them to explore other mediums of exchange like bills of credit. This marks one of the major pitfalls of commodity money, there is only a finite amount of the commodities in the world and at some point, we will run out.
As the years went by, governments began moving further and further away from commodity money as their legal currency. For a long time, there were efforts to have money whose value was backed by an underlying commodity, but even this practice became less and less practical. The popularity of commodity money has severely declined over the years mainly due to small supply relative to the demand for liquid currency. Commodities that had previously been coined and used as currency are still valuable, but are mainly viewed as safe haven investments. While gold and silver can still conceivably be used as a medium of exchange, individuals will always have to convert their ownership of these metals back to a commonly accepted currency in order to capture the true value. Commodity money has been extremely important throughout history, but was a more valuable system in the times of the ancient Greeks and Egyptians. Commodities remain a common store of value for investors, but their current monetary impact is nowhere near what it once was.
Before we move into the Theories and Mechanics section, watch this video. The history of commodity money clearly illustrates how necessary it is for citizens to have trust in the value of their money. Yet, almost every human society has moved away from this very idea. Ponder the question: ‘Is the liquidity and conveniency that fiat money provides worth overlooking the absence of intrinsic value that comes with it’?