The Gold Standard - Money versus Currency

Before money shows up

Since the beginning, our society felt the need of a way to exchange resources. The Barter probably was the first founded solution to exchange of resources or services for mutual advantage.

From 9000-6000 B.C., livestock was often used as an unit of exchange. Later, as agriculture developed, people used crops for barter.

Bartering has several problems, most notably the coincidence of wants problem. If a wheat farmer needs what a fruit farmer produces, a direct swap is impossible as seasonal fruit would spoil before the grain harvest. A solution is to trade fruit for wheat indirectly through a third, "intermediate", commodity, this way, the intermediate commodity money makes the market more liquid.

The writing, invented in Mesopotamia about 3100 B.C., had its main use, and probable motivation for its development, for keeping accounts of the exchanges made between people.

Stamped money

The first stamped Money was an Electrum (naturally occurring alloy of gold and silver) stater of a lion's head, coined at area of Lydia, and date about 610 - 560 B.C.

Although gold and silver were commonly used to mint coins, other metals could be used. For instance, ancient Sparta minted coins from iron to discourage its citizens from engaging in foreign trade.

An important effect of coins was that governments now controlled the release of money into the market. They could also manipulate the money supply. This was done by various Roman emperors, who would reduce the precious metal content of Roman coins when they needed money.

The birth of Banking

The Banking concept was originated in Babylonia about 3000 B.C., due the activities of temples and palaces which provided safe places for the storage of valuables.

By the sixteenth century a new form of money had appeared. Instead of taking the form of gold or silver coins, the new money comprised promises written on pieces of paper.

The money changers of the time were the goldsmiths, they had the premises and equipment necessary for working with precious metals. So began the practice of storing gold for other people, a service for which the goldsmith would charge a fee; the foundation of our modern banking system.

The Gold Standard

The Gold Standard is a monetary system in which the standard economic unit of account is a fixed weight of gold.
Under this kind of system, the money is said to be "backed by gold" and national money and other forms of money (bank deposits and notes) were freely converted into gold at the fixed price.

After the extinction of the gold standard, the governments could print as much money as it wanted because the money was no longer regulated by gold, thereby making it a Currency, and there is a huge difference between money and currency.

The Fiat money

Enters the scene the Fiat money. Fiat money refers to money that is not backed by reserves of another commodity.

The term derives from the Latin fiat, meaning "let it be done", as the money is established by government decree. Where fiat money (money that is intrinsically useless; is used only as a medium of exchange) is used as currency, the term fiat currency is used. Today, most national currencies are fiat currencies, including the US dollar, the euro and all other reserve currencies, and have been since the Nixon Shock of 1971.

Almost every country is on a system of fiat money. The value of money is set by the supply and demand for money and for other goods and services in the economy. The prices for those goods and services, including gold and silver, are allowed to fluctuate based on market forces.

So the government is free to produce their own money in any amount desired. When government produces money more rapidly than economic growth, the money supply overtakes economic value. This drives to a economic phenomena called Inflation (see How inflation erodes your investments).

Therefore, it is not surprising that the intrinsic value of gold has risen so much since then, as we can see below:

In conclusion

Money have a real intrinsic value, i.e., can be exchanged, at any time, by the commodity by which it is backed - such as gold, silver or precious stones.

Currency, that have no real value, is a form commonly acceptable as a medium of exchange. Since it is not backed by anything, its value is based in its ability to be circulated or be accepted by people.