On the Origin of Money
by Carl Menger
Economic Journal, vol. 2, (1892) p.239-55. Translated by C.A. Foley
[Abstract Review]
Menger talked about the development of money through the social/institutional structural. The article covered the genesis of media of exchange, the saleableness of different “commodity money”, and how metal became money. Most importantly, Menger stated the money is not generated by law but a product of social consensus. To understand the origin of money, it is worthy to find out why we need money?
Money has three functions in any economy: as a medium of exchange, as a unit of account, and as a store of value. The most original form of money is commodity goods: crops, live stocks, house, women, land, etc. At the time when people barter, people simply trade what they want with what they have. The system works fine except that the cost of transaction is high and trade faces its limitations. The saleableness of commodity is contingent to time and space; for example, the preservation of commodity increases the costs of transaction. If the commodity is a bunch of bananas, you’ll have to settle a deal before the fruit rotten. The price variations may also cause confusion in the market; for example, more bananas supply today and therefore purchasing power of bananas go down. The cost of carrying out transaction may exceed the benefits of exchange. The second challenge of using commodity goods as medium of exchange is how to store value. By this definition, banana is not a good candidate for money.
Recall that one of the primary functions of money is to store value; to ensure that the purchasing power don’t go down. Therefore, the best type of money is the kind that can reflect its true value during any circumstances. This corresponds to the “saleableness” of money, and the “market” condition.
From money’s three functions, it is easy to infer that money is not an institutional law but to a certain degree, a social consensus – the market. The value of money is free of government intervention. The logic is that government can impose a value, but it is left to the market to decide whether the law is reasonable. If the people do not accept such rule, they will trade using the way in which they believe is the most beneficial for themselves. This is most obvious in a time of hyperinflation when government issued currency loss value and the society exchanges using food, gold, or barter. The same case goes when the society loss faith in the government issued currency and decides to hold on to other medium of exchange that is better at storing value.
Money is mostly market-dependent and government-independent. Government can issue money in aiding the cost of transaction or provide a commonly accepted medium of exchange, but cannot prohibit other forms of mediums. It is the society to decide which type of exchange that is most efficient and the market decides the value or price of each medium of exchange.
ECON 500500 Reading and Writing in Economics
January 2nd, 2008