What Is Money?

The reason for writing this article is that what people have used as money over the millennia has changed hundreds if not thousands of times, yet this fact often gets lost. Throughout history we have shifted from using clay tablet as ledgers, to giant stones, glass beads, shells, salt, tobacco and even cattle as money. We find ourselves now in an increasingly digitised world but using a monetary system that is ~80 years old and creaking at the seams.

In this article I’m going to cover the often overlooked question of 'What Is Money?' It’s perhaps one of the most fundamental questions to the functioning of our society.

Take a moment to try and answer this question for yourself.

The origin of the word money is derived from the Latin word ‘monēta' – an ancient temple where coins were minted and named after the Roman goddess Juno Moneta the protectress of funds. But this doesn’t really answer the question: What is money? Fast forward to today and you might have heard Elon Musk describe money as “a database for resource allocation across time and space”. [1]

To better understand money, it can help to look at what problems money helps to solve. Three of the main problems that money helps solve are as follows:

1. Barter & The Coincidence of Wants

To give an example, imagine a fisherman who catches a variety of fish, and a blacksmith who specialises in making tools and knives. The fisherman, needing a new knife to clean and prepare his catch, approaches the blacksmith. He offers a portion of his daily catch in exchange for a well-crafted knife. The blacksmith, who values fresh fish for his meals, agrees to this exchange. Thus, they establish a barter system where the fisherman regularly supplies fish to the blacksmith, and in return, the blacksmith provides the fisherman with knives when he needs them. This mutual exchange benefits both and no money is needed.

The problem arises when the blacksmith may need some fish but the fisherman doesn’t need a new knife, perhaps the fisherman wants to purchase a new boat. Bartering relies on the coincidence of wants in order for trade to occur i.e., you want what I have and vice versa. The introduction of money solves this problem by offering a middle layer which allows the blacksmith to purchase the fish, and the fisherman to save this money up over time so that he may eventually purchase the boat from someone else such as the local boat maker.

In short, money means that two people don’t have to want what the other has to offer at the same time or at all. Money helps promote free trade and a better functioning economy.

2. Tracking value distribution across time and space

In 1912, JP Morgan famously stated in his testimony before congress “Gold is money. Everything else is credit.” To understand this a little more, let’s say that instead of using money, we use credit or debt. For example, if I was to purchase groceries from your shop for an entire year, but instead of exchanging money, I simply said that in return, I would offer you a discount at my car dealership when you are looking to buy your next car. Twelve months pass and the cost of manufacturing cars has gone up substantially. When you come to get a discount on your vehicle from my dealership, I state that my costs have increased well beyond expectations and that I can only over you a very small discount on the price.

The value of your groceries, and work involved to provide them to me have not been captured effectively and it’s hard to know what the fair discount on the car in return would be. Our reliance on a system of repaying favours or credit without a unit of account means that we probably won’t want to do a business transaction of this nature again. It’s complex, subjective, and often leads to disputes.

Obviously, this is a problem nobody wants to have, and waiting a year or more than a month or two is unthinkable for most merchants. Around the world people provide different products and services, each with different values. Without money and a standard unit of account, we find ourselves in a complex entanglement of bartering and negotiating what we think is the fair value at the time we want to trade. A unit of account puts a price on everything, meaning that whether you sell groceries, cars or houses, we can conduct trade at both ends of the scale.

3. Preserving value cross time and space

A store of value simply means that an asset is able to maintain or increase its value relative to the rate of inflation. For example, if you purchased a house 50 years ago and the price hasn’t increased, it did not maintain its value because inflation has meant the value of the currency is worth less. To maintain value, assets generally need to go up or at least stay above the relative rate of inflation for that asset class.

Generally speaking, assets that are scarce and highly desirable like beachfront property tend to provide better stores of value over time as there is always demand for them and often more money chasing them over time. The price of scarce desirable assets as a rule of thumb should increase as central banks create more money each year. This is also why the stock market goes up and why generally speaking the price of almost everything has increased over time. This is a basic principle that Andrew Sorkin of CNBC got badly wrong in this interview stating: “If it was a store of value, it would stay one price.” [2]

To conclude, we’ve covered that money is a technology that helps humans to solve three core problems that are encountered without it:

1.     Barter – money offers a medium of exchange

2.     Tracking value across time and space – a unit of account

3.     Preserving value across time and space – a store of value

Thanks for reading.