The origins of money

How did monetary systems evolve, and why is the government in charge? The conventional wisdom is probably wrong.

This is a slightly edited excerpt from my latest book, “Practical Doomsday".

There are countless pop-cultural clichés about how banks, financial markets, or the government are purportedly conspiring to deprive us of our wealth. To critically evaluate such claims, I find it useful to take a step back and consider how the financial systems came to be — and how they operate today.

The answer to these questions can be less obvious than we think. Take the origins of currency: virtually all textbooks explain the emergence of money in about the same way. The story begins with the parable of a farmer who raised a pig and a cobbler who made a pair of shoes; the cobbler needed to feed his family, and the farmer wanted to keep his feet warm, so they met to exchange the fruits of their labor on mutually beneficial terms. In doing so, our duo of Stone Age entrepreneurs invented primitive trade.

But, as the story goes, this system of barter had a flaw. It depended on the timely meeting of people who had closely aligned needs. This prerequisite — known as the coincidence of wants — could not always be easily satisfied. Sometimes a farmer wanted a cooking pot, a potter wanted a knife, a blacksmith wanted a pair of pants, and a tailor wanted some pork. It’s said that the irreducible complexity of such multiparty trades severely hindered early economic activity.

To address this problem, the textbooks continue, our ancestors eventually came up with a clever idea: the use of desirable, durable, and compact tokens as an intermediate store of value, effectively abstracting away the multi-step nature of many trades. A farmer would sell pork for a piece of shiny rock, and then take the rock to a cobbler to trade for shoes; the cobbler would later exchange his new rock for other goods or services, without the farmer needing to be involved in any way.

This brilliant scheme purportedly led to another problem. No two shiny rocks were quite alike, and with time, unscrupulous actors learned to produce counterfeit or adulterated rocks to procure unearned goods. And so, we are told, the common folk turned to their rulers for help, asking them to turn the metal into uniformly marked and distinctive coins, to distribute them throughout the realm, and to severely punish any fraud (executing the counterfeiter would be a pretty common remedy).

This explanation is pretty convincing but suffers from a fatal flaw: it’s almost certainly not true. In a 1985 paper on barter, Caroline Humphrey, a noted anthropologist from the University of Cambridge, bluntly remarked the following:

“No example of a barter economy, pure and simple, has ever been described, let alone the emergence from it of money; all available ethnography suggests that there never has been such a thing.”

It’s not clear where the parable of barter first originated. The most plausible explanation is that it’s the invention of early philosophers trying to wrap their heads around monetary systems. Thinkers from Aristotle to Adam Smith were forming their theories at a time when government-issued coinage was already ubiquitous, so they worked backward from the observed reality and concocted a plausible tale about human prehistory. Their speculations, without a shred of evidence, eventually morphed into the accepted truth.

Upon closer inspection, the pork-for-shoes tale of money has other problems. For one, for coinage to work, you need a system of prices — a widely shared and stable understanding of how many shoes a pig is worth, how many pigs should be paid for a horse, and so on. Without such a model, there’s no way to determine the kinds and quantities of goods a coin can safely and fairly replace.

But if there existed a way to relate the value of various items in common trade, that system of prices would permit financial contracts and rudimentary banking to take place without coinage. Obligations and account balances, perhaps measured in customary units such as bushels of grain, could be agreed upon and then tracked within communities. And indeed, financial ledgers of this sort are known to have existed throughout antiquity, at least as far back as Mesopotamia around 3,000 BCE — and quite possibly appearing far earlier than that.

In a popular book titled Debt: The First 5000 Years (Melville House, 2011), author David Graeber puts forward a thesis that ledger-based debt obligations were the natural foundation of early systems of trade, and that coin emerged much later and to serve a narrower need. Graeber’s theory is backed up by far stronger evidence than the barter parable — and its implications for our present-day understanding of money are significant too.

As Graeber tells it, early societies never had any difficulty keeping track of who owed what and to whom. Long before the emergence of written language, our Stone Age ancestors had a habit of keeping track of merchandise by making notches on sticks or animal bones, and by the early Bronze Age, fairly complex accounting would be done on clay tablets using cuneiform. All this predated the earliest known coinage — minted in the Kingdom of Lydia around 600 BCE — by more than 2,000 years.

Of course, in small and close-knit communities, debt was probably always handled in fairly informal and approximate ways, similar to our modern-day attitudes toward the exchange of goods and services among neighbors, family members, coworkers, or friends. In such settings, mutual and loosely tracked indebtedness serves as social glue more than a well-behaved financial instrument, and insisting on settling transactions on the spot — for example, demanding that your dinner guests reimburse you for the meal or offering cash to a friend who helped you with a move — could be taken as a slight.

But in larger societies where transactions tend to be less personal, the task of reconciling accounts appears to have been a more precise affair, delegated to trusted third parties since time immemorial. Cuneiform ledgers in Mesopotamia, for example, were kept in temples and presumably maintained by priests. However implemented, debt ledgers naturally enabled a wide range of economic activities within any stable, lawful society. Obligations could be paid back over time in one commodity or another, transferred, renegotiated, or forgiven, all without having to instantaneously settle trades.

If we accept the debt-based model of early economies, the first currencies almost certainly emerged as a straightforward consequence of the desire to settle on a particular unit of account. For example, if the aforementioned bushel of grain happened to be the most familiar and stable commodity in a particular region of the world, it would be simpler to track all account balances, and to quote all goods and services, using this quantity of grain as the reference point.

Unlike in the classical barter model, this unit of account didn’t need to be particularly durable, desirable, or easy to carry; it was simply an accounting tool. And indeed, unusual and easily damaged currencies of this sort are encountered throughout history — from the finished beaver pelts (“made beavers”) used by early European settlers in North America to the cigarette-denominated economies of many modern-day prison environments.

Given the millennia that seem to have passed between the development of fairly complex economies and the emergence of coin, it would appear that contrary to conventional wisdom, a tangible medium of exchange wasn’t in urgent demand for local economic activity in small tribes. Instead, as human settlements grew in size, merged with their neighbors, and occasionally went to war, the development of coinage can be more logically explained through the prism of widening networks of trade. When dealing with an unfamiliar or a possibly hostile buyer from faraway lands, the concept of a debt ledger doesn’t always hold up. The other side might be disinclined to honor its obligations and might be able to get away with it too.

In such settings, there’s clear merit to settling the transactions on the spot using physical tokens that are easy to carry, have a substantial intrinsic value, and enjoy nearly universal appeal. For much of the past 2,500 years, this role would commonly be filled by commodity money: round pieces stamped out of precious or semiprecious metals—predominantly silver and gold.

At first, such coins coexisted with customary agricultural units of account and served a specialized purpose, but with the advent of sprawling continental empires, people embraced metals as the prevailing way to measure wealth or settle debts. Ledgers and contracts remained the basis of much of global economic activity—but the accounts were now denominated in coin instead of grain.