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What is money?

The Oxford English dictionary describes money as “A current medium of exchange in the form of coins and banknotes.”

But what exactly does this mean, and how did it develop? How did we move from exchanging cattle for goods, to being able to exchange “invisible” money, such as electronic and virtual money, for goods and services today?

We will briefly explain the answers to those important questions, as a logical first step, on your journey to master the art of money. This insight into the fascinating development of money will provide a useful historical background, as a foundation for everything that follows.

 

The early days of money

In the early days, long before money was invented, people exchanged or swapped goods and services, through a system called barter.

This enabled people who owned one thing, to exchange it for another thing that they needed or wanted. For example, if John was a chicken farmer, who owned hundreds of chickens, but wanted some wheat to make bread for a sandwich, he would have to find someone who grew and owned wheat.

Once he had found such a person who owned wheat, he would then need to barter, meaning “exchange” with them, and swap his chickens for wheat.

Let’s assume John goes to the local market and finds Ava, who grows wheat. A barter discussion could then begin, which may go something like this:

JohnHey Ava, I need a bag of wheat to make some bread, I will exchange one chicken for one bag of wheat.”

AvaI don’t think so John, wheat is in short supply this month, so I want four chickens for my bag of wheat.”

JohnFour chickens for a bag of wheat! It was only one last month.”

AvaOk, I can come down to three chickens, but that is as low as I can go.”

JohnThree chickens is still too much, my best offer is two chickens, and that’s it.”

AvaYou pushed a hard deal John, but price agreed, two chickens for a bag of wheat.” 

John has bartered and agreed to exchange two chickens for one bag of wheat. So the “price” of one bag of wheat, on that particular day, was two chickens.

But what if John also needed some grain to feed his chickens, some hay to feed his horses, some apples for himself, and also the services of a thatcher, to fix a leak in his thatched cottage?

This would take a very long time to barter, and as you can see from the previous example, John doesn’t know what the eventual exchange price will be, so it’s difficult to plan ahead, with how much things cost.

Think about the potential problems if you had to barter for everything during a trip to the local supermarket. It would be a very time consuming and confusing experience, to say the least.

What if you owned apples, but needed fish?

You would first need to find someone who not only has fish but also wants some apples. What if that person with fish doesn’t want apples, but does want bananas? You would then have to find someone who has bananas and wants apples, in order to exchange your apples, for their bananas, and then you can exchange your bananas, for their fish.

Confusing isn’t it!

This is why a more reliable, and consistent measure of exchange was required for buying and selling things. An agreement would need to be made between all buyers and sellers, about how much each thing or item was worth.

This led to the creation of the first type of money, called commodity money.

FACT: Bartering is thought to have existed for at least 100,000 years before it developed into modern-day money.

Commodity money

Commodity money has taken many different forms throughout its development around the world. The word “commodity”, simply means an item that has some value attached to it.

Commodities used to trade with would usually have certain characteristics attached to them. They would be desirable and therefore valuable, hardwearing and durable, portable and easily stored.

Examples of commodity money include seashells, beaver pelts, dried corn, silver and gold. These commodities had agreed and accepted values and could be used to buy and sell other things.

Using our example above, John would now be able to carry commodity money, such as seashells with him, knowing he can buy wheat at four shells per bag, and he can sell his chickens for two shells each, making it far easier and more certain for him to buy and sell things.

It can therefore be seen, that commodity money was a more reliable medium of exchange between buyer and seller than the barter system.

Money as a Medium of exchange

As well as being a medium of exchange, money also has other uses.

It helps to store value. For example, if you were given a pack of strawberries worth £5, you could eat them now, and enjoy £5 worth of strawberries, but if you didn’t eat them for a week or so, they would go off, and the £5 value of the strawberries, would just disappear to nothing. But if you were given £5 worth of money instead, you could keep it safely wherever you wanted, for as long as you wanted, and then spend it at a time of your choosing. This is called a store of value.

Businesses and people also use money when they value or price things. If you want to buy a new mobile phone, you’ll be charged in Pounds and Pence or Dollars. The price could be listed in other units, such as chickens, wheat or shells etc., but money offers a shared standard, that everyone can use and understand, making it easy to compare prices. This is called a unit of account.

What if your new phone cost 50 chickens in one shop, 40 bags of wheat in another, and 100 seashells in a third?

 

That would make it very difficult to compare who was the best value, and just imagine the mess of taking 50 chickens into the Apple store!

FACT: 96% of all money in the UK, is held electronically as deposits, with just 4% held in physical form as cash.