The classic example of a commodity money is that of Cowry Shells; cowries have been used as money throughout much of Africa and Asia, and even the Americas and Australia. The local value of these shells would of course depend on the local supply and demand at any given time.
In Fiji, the local people at one time used whale teeth as money. Apparently, there are both white whale’s teeth and red whale’s teeth, and they would exchange at different values according to their scarcity.
A common feature of many of these early forms of commodity money was their ornamental value, implying that they had at least some intrinsic value of their own and did not rely entirely on their use as a means of exchange to derive their value. The idea of intrinsic value, or lack of it, is one of the main criticisms of cryptocurrency today. It is an important consideration, and one that continues to divide opinion among many top investors in the financial asset space. Returning to our early civilizations, whilst agricultural commodities have no ornamental value, their intrinsic value was derived from their value as food.
As agricultural harvests grew, many civilizations used grains as the bedrock of their economies. Ancient Rome was an agrarian society, and wheat was commonly used as money. Similarly, corn has been used as money throughout Europe from the time of the Ancient Greeks right up to the period of the industrial revolution.
Corn has even been deposited in Banks, and then borrowed and lent, thereby satisfying yet another function of money i.e. that of a ‘standard of value’. You may have heard of the term ‘corn-exchange’, this has particular relevance to Victorian Britain where corn was a major commodity for trade purposes (the word ‘corn’ was used in relation to all grains including wheat and barley).
Around the Mediterranean, olive oil has been used as a commodity money. Central America has used both maize and cacao nuts as money.
During World War 2, the Red Cross would deliver food packages to allied prisoners that contained various items including cigarettes. Those cigarettes were more durable and storable than the other items, and not all prisoners were smokers. That motivated the exchange of cigarettes for chocolate and other items. Before long all available items had a price in terms of cigarettes, and so cigarettes had become a form of commodity money.
As all these examples from history offer some important lessons; money is an essential component of efficient trade, and wherever there is an opportunity for mutually advantageous trade there will usually be something being used as money in order to facilitate that trade.
Commodity Money Examples
Altogether I have mentioned 11 types of commodity money that humans have used:
- Skins and Furs
- Precious metals
- Cowry shells
- Whale’s teeth
- Olive oil
- Cacao nuts
If this list seems like a long one, I should point out that it doesn’t even scratch the surface. At various times and places there has been an almost endless list of other types of physical commodity that has been used as money but, as mentioned already, precious metal is by far the most important. Gold and Silver have both been used throughout history, and perhaps they will again someday soon if the current precarious experiment with fiat money comes to an unfortunate end.
Commodity Money Vs Fiat Money
I have previously written about the characteristics of money on my page about the different types of money, so I won’t repeat myself here, but it suffices to point out that of all the potential commodity monies to choose from, the precious metals offer the best fit with the characteristics of money.
As Jevons puts it:
With the introduction of coinage (estimated to have been invented sometime around 900 B.C.) the formation of gold and silver into standardized units greatly increased the usefulness of these metals for circulation through the economy, which thereby facilitated new trade and commerce.
Gold in particular has, for long periods of our history, been the standard of value by which international debts have been settled. Even in the modern age a country's gold stock is still held as a financial asset by central banks, and it constitutes a large part of their ‘official reserves’ which are used to support the value of the domestic money supply by smoothing out short-term fluctuations in exchange rates.
Advantages of Gold over Fiat Currency
With gold being the ultimate commodity money, it is worthwhile to consider whether or not it is a superior money to our current fiat monies. I’ll start with the advantages:
- The supply of gold is stable – this has the very important advantage of preventing governments or banks from over-expanding the money supply and thereby causing inflation.
- Gold has real intrinsic value – meaning that it is unlikely to ever collapse without value, which is precisely what has happened to every fiat money in history.
- The Gold Standard was the predominant monetary system in the west for the 50 years from 1870 to 1920, a system where legal tender was convertible into gold coin, and a period of unrivaled economic growth and stability.
- Gold has a 5000-year track record of being the ultimate safe asset in times of economic turmoil.
Disadvantages of Gold
- In the modern age gold is not suitable as a commodity money because it is not as portable as fiat money. Having to pay with physical gold rather than being able to pay with a credit/debit card is not feasible. Of course, this could easily be overcome by issuing paper money and credit money that is convertible into gold at a fixed rate (i.e., a gold-standard) but this would be a representative money rather than a strict commodity money.
- The stable supply of gold means that it cannot be expanded fast enough to keep up with new growth in the economy. The implication is that we would have to accept ongoing deflation (falling prices of goods and services) and that this would suppress economic growth rates.
This assertion, that the economy’s growth rate would be suppressed, is unproven.
The idea is rooted in the fact that we only ever experience deflation, across the entire economy, at times when consumer spending collapses for one reason or another. The lack of spending during these periods is bad for business as it implies unsold goods, which leads to reductions in production and increased unemployment due to redundancies. That in turn leads to even less money being spent and a downward spiral of economic output reminiscent of what occurred during the Great Depression.
In contrast, the deflation of prices related to technological goods is clear evidence that falling prices are not detrimental to economic growth. People do not avoid buying the latest smartphones simply because they expect prices to be lower in future, so the whole argument against gold or other types of commodity money is misplaced.
Monetary Lessons & the Future Outlook
I have written about the shortcomings of our current monetary system in my article about the money multiplier and fractional reserve banking, and I have presented what I believe to be the best alternative to it in my article about full reserve banking. Without repeating myself I think that it should be clear to the reader that the major western economies are, in the first half of 2022, in deep trouble.
Our fiat money is losing purchasing power at the fastest rate for over 40 years, and our national debt levels are so high that we cannot realistically hope to pay it off if interest rates were to rise by more than a few percentage points. In fact, we already lack the resources to pay it. The government budget deficit is enormous and, coupled with an enormous trade deficit, our only solution has been to borrow more and more money.
This is not sustainable, and a catastrophic global monetary collapse seems imminent.
The question is, what will replace fiat money when that collapse occurs? Much of the current policy development in the United States and other western countries appears to be focused on the introduction of a Central Bank Digital Currency (CBDC). We don’t have details at the time of writing on how this would be managed, but in any case, it seems quite impossible that confidence in a debased national currency like fiat money could be restored simply by introducing a digital form of that money.
It seems likely that a commodity of real value will be needed in order to back CBDC, and full convertibility into that commodity will be needed.
In their January 2022 publication, the Federal Reserve Bank has set out a framework for public discussion about the future on Money & Payments in the US. The very first paragraph of the executive summary in that document evidences their total blindness to reality:
“The Federal Reserve, as the nation’s central bank, works to maintain the public’s confidence by fostering monetary stability, financial stability, and a safe and efficient payment system.”
The entire history of the Fed, as with other central banks (with the possible exception of the German Bundesbank) has been an exercise in failure. It has always been heavily influenced by political pressures, and it has consistently failed to take decisive action on the money supply in a timely fashion when circumstances have required it.
On page 13, the report goes on to specifically state:
“As a liability of the Federal Reserve, however, a CBDC would not require mechanisms like deposit insurance to maintain public confidence, nor would a CBDC depend on backing by an underlying asset pool to maintain its value. A CBDC would be the safest digital asset available to the general public, with no associated credit or liquidity risk.”
I fail to find the words to describe my astonishment at the hubris demonstrated here... Having debased the US dollar via excessive expansion of the money supply via quantitative easing (money printing), which has directly caused a collapsing level of confidence in the dollar due to high inflation, the Fed states that no underlying asset is needed to back their proposed CBDC, and that their management alone is enough to ensure confidence. This is beyond delusional!
If a future CBDC is not backed by an underlying commodity of real value then why should people trust it any more than fiat bank notes? If it could be converted into a physical commodity such as a precious metal then it would be much more convincing as a viable and stable money alternative.
The lessons of previous failures must be learned, the Federal Reserve System is not a credible monetary authority, and no money is safe under its stewardship unless it is convertible into a valuable commodity at a fixed rate of exchange.
Commodity money was the first sort of money used by humans to purchase goods and services, and even in modern times gold, the ultimate commodity money, is held by central banks as part of a diversified portfolio of financial assets that form their official reserves.
Modern fiat money has no intrinsic value in the way that commodities do, and its value is based purely on its acceptance as a medium of exchange. All historical attempts at maintaining a fiat currency have failed, usually with disastrous consequences, and ultimately with a return to commodity money.
If our current fiat system fails, what replaces it will more likely be a new representative money rather than a strict commodity money. Any CBDC will likely fail with the failure of fiat money, unless it is backed by a valuable commodity.