In today’s world, whenever you see a government or a country collapsed due to war, you’ll see the citizens of the country scrambled to ditch all their savings of money in exchange for food, and they save food (or even gold) instead of money. Why? Why the citizens ditch their money as if their hard-earned money is no longer valuable?
To explain this, we first need to understand “How money is created”. So, how money is created?
Let’s pore over the school’s economics textbook, where we learn about the narrative of “How money is created” from system barter:
- Let’s say a fisherman, he wanted some vegetables. He can bring the fish he caught to the farmer that wanted some fish and exchange the fish for vegetables produced by the farmer.
- In other words, the fisherman sold fish to the farmer and accept vegetables as payment. In the same way, the farmer sold vegetables to the fisherman and accept fish as payment.
- This works well. But… what if the farmer didn’t feel like eating fish for a month and thus doesn’t want to accept fish as payment for the vegetable he produces.
- The fish is not accepted as payment since the fish isn’t something the farmer sees valuable now.
- Then, the exchange can no longer happen. The fisherman is not happy because he couldn’t get the vegetable he’s hungry for.
- In other words, system barter requires “double-coincidence-of-wants-of-commodity” in order for a trade/exchange to happen.
- Thus, to solve this “unhappiness”, they invented the medium of exchange – a commodity called money.
- Money is thus – A commodity that everyone is willing to accept as payment for the goods and services they offer (simply because everyone think it’s valuable and thus other people will be willing to accept it as a payment also).
- Throughout the history, we have salt, sugar, shells, precious metal such as gold, silver etc as the medium of exchange.
- People priced their goods and services they offered in terms of the medium of exchange. For example: a cup of rice is priced at two pound of silver.
- Slowly, to standardize and facilitate the transactions in the market, the government choose a unit of account (let’s say: dollar), and issue their own state money (coins) minted with precious metal such as gold.
- If a one-dollar gold coin is minted with a x pound of gold, a two-dollar gold coin should be minted with 2x pound of gold.
- People starts to price their goods and services they offered in terms of dollar and accept the dollar gold coin as a payment.
- Why do they accept the gold coin as payment? Because the coin is made of gold! Who doesn’t want gold? In other words, they accept it because they believe other people will accept it too (gold is valuable on its own)!
- A farmer sells vegetables for 1 dollar accept one-dollar gold coin as payment because he believes the coin is minted using gold that actually worth 1 dollar.
- The farmer believes the intrinsic value of the gold coin is 1 dollar.
- Hence, people start to associate a certain weight of gold to the unit of account. For example x pound of gold represent 1 dollar.
- Logically, 2x pound of gold represent 2 dollar. 3x pound of gold represent 3 dollar and so on. This is what we called the “metallic standard of value”.
With the idea of “metallic standard of value” in place, we shall dive into the “Metallic Theory of Money”:
Metallic theory of money
This theory suggest money is valuable/accepted as payment because of the intrinsic value of the metal that the money contains. Let me put it this way, people accept one-dollar gold coin as payment for goods and services they offer because they think that the gold coin is minted using a certain amount of gold that actually worth 1 dollar.
Is that what really happen? Is it true that people accept one-dollar gold coin as payment for goods and services they offer because they think that the gold coin is minted using a certain amount of gold that actually worth 1 dollar? Is it true that money is valuable/accepted as payment because of the intrinsic value of the metal it contains?
No, that’s not true at all. The history has proven it many times. Or a quicker way, just look at the paper money in your wallet now.
Do you think people accept one-dollar paper money as payment because the paper money is created using a special paper that worth 1 dollar? No way. The special paper that is used to make 1 dollar paper money might not even worth 0.0001 dollar.
They accept it as a payment for the goods and services they offered for other reason, but certainly not because of the intrinsic value of the money.
Need more space to explain this. Check out my next follow-up article!