Commodity Money Definition & Examples

The earliest forms of commodity money can be traced back to earliest days of human development, right back to the time of the hunter-gatherer.

Necessity has always been the mother of invention and one of the most basic necessities of life is trade. Without trade there is little hope of long-term survival, and no hope at all of any standard of living beyond the most meager level of subsistence.

Given the importance of being able to trade with our fellow humans, the necessity of developing some sort of medium of exchange that would be readily accepted as a means of payment for various items presents itself.

Money is, of course, that medium of exchange, and throughout our history there have been many different forms of money.

What is Commodity Money?

The most basic definition of money is that: ‘anything which acts as money, is money’. In other words, anything that is widely accepted as a medium of exchange to facilitate trade, can be called money. However, this is not an ideal classification as there are several other functions of money.

Commodities, of one sort or another, were best suited to the ‘medium of exchange’ function for most of human history.

Whilst our hunter-gatherer friends lacked access to modern money, they did have access to commodities. The meat that they hunted would not be good as a medium of exchange because it would quickly spoil, but the skins and furs that they trapped were durable, and could be used as a basic form of commodity money.

Historical evidence shows that skins and furs were indeed used as money to purchase all manner of other items.

The Evolution of Money

The evolution of money has not always unfolded in a constant progression from a basic form of money to a better form of money and so on. There have been many circumstances in our early history where advancements were undone by war, famine, natural disasters and so on. As with so many of our modern accomplishments, most of the evolution of money took place after the industrial revolution.

Our current fiat monetary system only came into being in 1971 with the collapse of the Bretton Woods system of money i.e. a system where international currencies were convertible into dollars at a fixed exchange rate and the dollar itself was convertible into gold at a fixed rate. For more details on the development of paper money, or representative money, see my article at:

• Representative Money

For information on the latest development of money, including cryptocurrency and central bank digital currency, have a look at my article:

• Types of Money
  

On this page I will focus on the earliest evolution of money from the barter system to various types of commodities that have been used as money. I’ll also ponder some of the frailties of our current monetary system and the possible return to a representative money if the ravages of inflation and debasement irreparably undermine our confidence in fiat money.

From Skins/Furs to Cigarettes

As indicated above, the earliest example of commodities being used as money dates right back to our hunter-gatherer days when skins & furs were used for trade purposes in order to obtain all manner of other available items.

Moving forward to our earliest civilizations, which were built on agriculture and animal husbandry, we find that cattle was used as money. One major advantage of cattle over skins and furs was that it could be more easily transported, and was relatively more durable, meaning that animals could perform some of the other functions of money beyond a simple medium of exchange.

The price of all manner of tradable items would be quoted in terms of an equivalent number of oxen, meaning that cattle served as a unit of account.

However, cattle could not perform all of the functions of money, and precious metals were usually used alongside cattle to perform the function of a store of value and a standard of value for large amounts of money.

When the precious metals took on more of the duties of money, they began to take on local names that were derived from the local term for cattle. When those metals were turned into coinage, they would often be stamped with the image of an ox or other types of cattle. The word ‘fee’, denoting the payment of an amount of money, is derived from the Anglo-Saxon term ‘feoh’ which was the term used for both money and cattle. 

Whilst the precious metals, gold and silver in particular, are the best form of commodity for use as money, their scarcity in many places of the world meant that they simply weren’t available for use, and so a very wide range of alternative commodities have been used instead.

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:

1. Skins and Furs
2. Cattle
3. Precious metals
4. Cowry shells
5. Whale’s teeth
6. Wheat
7. Corn
8. Olive oil
9. Maize
10. Cacao nuts
11. Cigarettes

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 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:

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.

Final Thoughts

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.

Sources:

• W. S. Jevons – Money and the Mechanisms of Exchange
• Federal Reserve Bank – Money & Payments
  

Related Pages:

• Types of Money
• Representative Money
• The Quantity Theory of Money
• Loanable Funds Theory
• Liquidity Preference Theory
• The Money Multiplier
• Full Reserve Banking

ShareFacebookTwitterPinterestTumblrRedditWhatsApp