Wait a sec; what *is* money, exactly?

Thursday, May 22, 2014

For most of us, it’s that thing that keeps us awake at night. The thing which seems to perform magic tricks by disappearing right before our eyes or by arriving in equally magic ways to open doors to freedoms and adventures beyond imagination. It has many colours and shapes, myriad values and infinite uses. It can imprison us and liberate us in equal measure. For something so central to our lives, it seems it should be part of nature, like a universal energy used across all times and understood by life forms of all kinds. But, of course, money is a human invention - and a relatively recent one at that. But still, it may define us a species. So, what is it really?

Essentially money is a means of economic exchange. You know this, but to break it down, money is a means by which goods and services can be circulated in a society, allowing for the things we need and want to be bought and sold with something approaching a free flow.

Prior to money we had barter. One thing was swapped for another – one apple for a couple of eggs, or perhaps an hour's labour for a few pieces of meat – and that was good enough to keep human economies ticking over for centuries. Its weakness was that it could be hard to find things you really wanted. If you needed, say, a pair of shoes, you needed to find someone with shoes and then hope you had something they wanted in exchange. If you didn't have anything they wanted, you had to enact however many exchanges to get what the shoe owner wanted. It might take you weeks in which time you could have made your own shoes. It was cumbersome and hardly ‘flowing’.

However, the principle of exchange was established. The trick was to establish a readily exchangeable form to use as the medium, something everybody could use. Shells were a common early form of currency across many societies. But, shells could be found anywhere and as money economies became more evolved, money became a rarer, more specialised commodity.

The Chinese, they developed a form of copper money in the seventh century which was quickly replaced by paper money; no one ever invented a wallet big enough to fit large copper slabs.

Banks, which began appearing in Europe about one thousand years after Chinese paper money, constitute a vital part of the global money story. This is particularly the case with reserve banks, which had the authority to manufacture money and to distribute it. To allow them to do this, the governments that backed reserve banks had to take control and centralise their economies.

It was at least partly for this reason that the nation-state was born.

With the development of banks, things became really interesting. Because in the early days nation states were a new concept and governments were little more then an annoying group of people who keep wanting things (some things never change), states had to back money with something tangible to get people to use it. In Sweden, for instance, where the concept of reserve banking was developed in the mid-seventeenth century (by a Dutchman), the backing took the form of pieces of copper and silver called daler (Yep, that's where the term dollar comes from).

With the backing of a powerful state, money took on a life of its own. It became the medium of exchange. The government-backing arrangement continued more or less until the 1970s when the standard of backing all coin and paper money with gold reserves – and the promise to provide the bearer of legal tender with the equivalent value in gold at any time - was effectively ended. Then, money became something else again.

Now that money is not effectively backed by anything other than the fact that a given state government says it backs it (which impinges on how everyone else values a given national currency) it has become something more complex and difficult to pin down. Governments no longer promise to swap the bearer of physical money anything upon presenting it. If you or I went to the Reserve Bank with a five dollar note and said “I want what this promises me”, I'm not sure what we'd get (other than a blank stare and possibly thrown out). Money is worth what we think it is. It's valued by a massive consensus, and that changes every day, every millisecond in fact and sometimes by a lot.

Author John Lancaster said in a recent BBC analysis of money, “Money is a collective act of the imagination, and it's a thing which we have invested our credence in, and it works because we do that."

So, it’s all about trust.

Which is why, when we have a challenge to the culture of trust, say in the shape of the Global Financial Crisis of 2008, that governments rush to restore confidence and stability. In Australia, we had every bank backed by government guarantee, which the commonwealth could do because it alone has the authority to make money if it needs to, and in the US we had Qualitative Easing and the mass printout of more and more greenbacks.

But, while it may seem a little scary, and perhaps a little kooky, that we all buy into the money game, there's something encouraging about the fact that pretty much all of humanity can agree on something and trust in it. While we can all lament the woes of war and a seemingly genetic ability to misunderstand each other and fail to agree, the modern consensus on money is surely encouraging. While opinions on it may vary, pretty everyone agrees enough to use it and this mutual agreement has probably stopped as many wars and fallouts as have been started in money's name.