Since the dawn of money, money has had three major eras: commodity money, representative money and fiat money.
Now we are seeing the birth of the fourth era: digital money like Bitcoin.
The first era of money was commodity money. Commodity money is money made of a commodity. There is much ancient history documenting commodities of all sorts being used, like shells and grains. Initially, commodity money was used mostly for individual or local transactions.
Commodity money took a huge step forward when it started being made of metals. The first mention of silver and gold coins were the ones being used by the Lydians around 650 B.C. They were a big improvement over other commodities: more durable, more rare and more portable.
And the development of coins was a very useful innovation. It standardized weight and content, especially when made by a government, and the designs made coins easily recognizable. The result was that they were more easily exchanged. Because its value is determined by the value of the commodity used to make it, a $20 gold coin would have $20 worth of gold in it.
The second era of money was representative money. Representative money, also known as commodity-exchange money, is a proxy with a guarantee that it can be exchanged for a fixed amount of a commodity, like a precious metal. The most common form is a paper bill like the silver certificates used in the United States. For example, a $10 silver certificate could be redeemed for $10 worth of silver.
This form of money solved the problem of whenever the logistics of transporting silver and gold were impractical. This innovation enabled larger economic transactions, especially enabling trade between countries and therefore global economic growth.
Commodity money and representative money existed side by side for most of history. They both were rooted in a commodity that had intrinsic value and therefore viewed as sound money. For example, in the United States, silver and gold were used in higher denomination coins along with silver and gold certificate bills. The user would be free to use the form of money that was the most practical for each transaction.
In the period leading up to World War II, commodity and commodity-exchange money began falling out of favor. The global economy was suffering from the Great Depression and the world was headed toward war. Governments wanted more money to stimulate the economy and fund their military buildups. But they already made all the money their precious metal reserves would allow. They could only make more money if they grew their reserves.
But mining new metals would take too long. And the production volumes would not be large enough to make the large amounts of money that governments wanted to make. That ended commodity money in 1933 and began the representative money.
The third era of money is fiat money. Fiat money’s value is determined solely by government order, also known as fiat. It has no intrinsic value itself nor is there a guarantee that it can be exchanged for a valuable commodity. Instead, the government decrees it legal tender, meaning that it is unlawful not to accept it as payment. No longer was money linked to anything of value, but instead its value was based on the confidence in the government that made it.
Fiat money came into being in 1976 when the U.S. government officially changed the definition of the dollar to remove any reference to gold. It was the final nail in the coffin. Until then, the fact that the U.S. dollar could be exchanged for gold was limited to between countries and their central banks. Individuals and companies were excluded from convertibility beginning in 1933.
All other countries’ monies were backed by its exchangeability with the U.S. dollar through foreign exchange trading, and the U.S. dollar was backed by its exchangeability with gold between countries. Now, for the first time in history, the world’s monetary system was completely decoupled from anything of tangible value.
We are witnessing the birth of the fourth era of money, namely digital money like bitcoin. Digital money is money that exists solely in cyberspace. Unlike fiat currency, bitcoin is created by a decentralized network instead of a centralized government. Its value is determined by the free market and not government fiat. And like commodity money, it is rare (only 21 million bitcoins can be created), durable, easily divisible (currently up to 9 decimal places), cannot be duplicated and can easily be identified through its unique cryptography.
It is interesting to note that the first bitcoin was created in 2009. Recall that was after the financial crisis and nearing the peak of the Great Recession. The Federal Reserve began a series of stimulus programs to flood the economy with newly created fiat currency in hopes of shocking the moribund economy out of recession. With each dose of stimulus having little impact, the Fed dramatically boosted money supply by $4.5 trillion. That could only be accomplished with fiat money but puts at risk the confidence in the U.S. government and therefore the value of the dollar.
The last major shock to the money supply ushered in a new era of money. The era of commodity money abruptly closed in the U.S. in 1933 and started the end of representative money, which disappeared in 1973. In 1933, the newly elected FDR had no ability to make additional money to stimulate the economy out of the Great Depression. Through a combination of confiscating American’s monetary gold and unilaterally increasing the price of gold, President Roosevelt increased America’s money supply from $4 billion to $21 billion. The result was the collapse of the commodity and representative monetary systems.
It appears that history is repeating itself. The current shock to the money supply is ushering in a new era of money.
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