Any commodity that acquires a high degree of acceptability throughout the economy thereby becomes money. Consider some commodities used as money over the centuries. Cattle served as money, first for the Greeks and then for the Romans. In fact, the word pecuniary comes from the Latin word pecus, meaning "cattle." Other commodity moneys used at various times include tobacco and wampum (polished strings of shells) in colonial America, tea pressed into small cakes in Russia, and dates in North Africa.
Whatever serves as a medium of exchange is called money, no matter what it is, no matter how it first came to serve as a medium of exchange, and no matter why it continues to serve this function. So long as there is something that sellers willingly accept in exchange for whatever they sell—rather than looking around for goods they in particular would like to consume—that article is money, whether it is animal, vegetable, or mineral. The only test for money is that it be widely accepted in return for goods and services. Some kinds of money perform this function well, others not so well. But good or bad, it is all money.
Problems with Commodity Money
Corn does as well as some other commodities that have served as money throughout history. But there are problems with most commodity moneys, including corn. First, corn must be properly stored or its quality will deteriorate; even then, it will not maintain its quality for long. Second, corn is bulky, so exchange becomes unwieldy for major purchases. For example, suppose a new home cost 50,000 bushels of corn. Many truckloads of corn would be involved in such a transaction. Third, if all corn is valued equally in exchange, people will tend to keep the best corn and trade away the lowest-quality corn. The quality of corn in circulation will therefore decline, reducing the acceptability of this commodity money. Sir Thomas Gresham, founder of the Royal Exchange of London, pointed out back in the sixteenth century that "bad money drives out good money," and this has come to be known as Gresham's Law". When moneys of different quality circulate side .by side, people tend to trade away the inferior money and hoard the best.
A final problem with corn as with other commodity moneys is that the value of corn depends on its supply and demand, which may vary unpredictably. On the supply side, if a bumper crop increases the supply of corn, corn would likely become less valuable, so more corn would exchange for all other goods. On the demand side, any change in the demand for corn as food would alter the amount available as a medium of exchange, and this, too, would influence the value of corn. Erratic fluctuations in the value of corn limit its usefulness as money, particularly as a store of wealth. If people cannot rely on the value of corn over time, they will be reluctant to hold it as a store of wealth. More generally, since the value of money depends on its supply being limited, anything that can be easily produced by anyone would not serve well as commodity money. For example, dirt would not serve well as commodity money.
Metallic Money and Coinage
Throughout history several metals were used as commodity moneys, including iron and copper. More important, however, were the precious metals— silver and gold—which have always been held in high regard. The division of commodity money into units was often quite natural, as in a bushel of corn or a head of cattle. When rock salt was used as money, it was cut into uniform bricks. Since salt vas usually of consistent quality, a trader needed only to count the bricks to determine the amount of money. With precious metals, however, both the quantity and quality became open to question. Because precious metals could be debased with cheaper alloys, the quantity and quality of the metal had to be ascertained with each exchange.
This quality-control problem was addressed by coinage. Coinage, when fully developed, determined both the amount of metal and the quality of the metal. The use of coins allowed payment by count rather than by weight. Initially, coins were stamped only on one side, but undetectable amounts of the metal could be "shaved" from the smooth side of the coin. To prevent shaving, coins were stamped on both sides. But another problem arose. Because the borders of coins remained blank, small amounts of the metal could be "clipped" from the edges. To prevent this, coins were bordered with a well-defined rim and were milled around the edges. If you have a dime or quarter, notice the tiny serrations on the edge plus the words along the border. These features, throwbacks from the time when these coins were silver rather than a cheap alloy, prevented the recipient from "getting clipped."
The power to coin money was viewed as an act of sovereignty, and counterfeiting, an act of treason. In England the king extended his sovereignty only to silver and gold coins. When the face value of the coin exceeds the cost of coinage, the minting of coins becomes a source of revenue to the sovereign. Seigniorage refers to the amount of precious metal extracted by the sovereign, or the seignior, during coinage. Debasement of the currency represented a source of profit for profligate governments. Token money is the name given to coins whose face value exceeds their metallic value.
Money and Banking
Early banks were little more than moneychangers, exchanging coins and bullion (uncoined gold or silver bars) from one form to another for a fee. Money was counted on a banque, the French word for "bench." Banking, as the term is understood today, dates back to London goldsmiths of the seventeenth century. Because goldsmiths had a safe in which to store gold, others in the community came to rely on goldsmiths to hold their money and other valuables for safekeeping. The goldsmith found that when money was held for many customers, deposits and withdrawals tended to balance out, so a pool of deposits remained in the safe at a fairly constant level. Loans could be made from this pool of idle cash, and the goldsmith could thus earn interest.
The system of keeping one's money on deposit with the goldsmith was safer than leaving money where it could be easily stolen, but it was a bit of a nuisance to have to visit the goldsmith each time money was needed. For example, the farmer would visit the goldsmith to withdraw enough money to buy a horse. The farmer then paid the horse trader, which promptly deposited the receipts with the goldsmith. Thus, money took a round trip from goldsmith to farmer to horse trader and back to goldsmith. Because depositors grew tired of going to the goldsmith every time they needed to make a purchase, the practice developed whereby a purchaser, such as the farmer, wrote the goldsmith instructions to pay the horse trader so much from the farmer's account. The payment amounted to having the goldsmith move gold from one stack (the farmer's) to another (the horse trader's). These written instructions to the goldsmith were the first checks.
By combining the idea of cash loans w4th checking, the goldsmith soon discovered how to make loans by check. The check was a claim against the goldsmith, but the borrower's promise to repay the loan became the goldsmith's asset. The goldsmith could extend a loan by creating an account against which the borrower could write checks. Goldsmiths, or banks, in this way were able to "create moneys—that is, create claims against themselves that were -generally accepted as a means of payment—as a medium of exchange. This money, though based only on an entry in the goldsmith's ledger, was accepted because of the public's confidence that these claims would be honored. The total claims against the bank consisted of customer deposits plus deposits created through loans. Because these claims against the bank exceeded the bank's gold and other reserves, this was the first fractional reserve banking system, a system in which only a portion, or fraction, of deposits were backed up by reserves. The reserve ratio measures reserves as a proportion of total deposits. For example, if the goldsmith had reserves of $5000 but total deposits of $10,000, the reserve ratio would be 50 percent.