The Changing Nature of Money: How We Got Here and What's Coming Next.

The nature of money is one of the key defining features of civilization. It’s tempting to think that money is a relatively stable thing and that, aside from a few ups and downs, it always works basically the same way.

However, nothing could be further from the truth.

Of the 750 or so currencies which have existed since the 1700’s, only around 20% of them are still around today. Also, the underlying rules which govern how money works (monetary regimes) have fundamentally changed no less than three times in the past 107 years.

If you’re 51 years old as I write this, you’re actually one year older than the currently dominant monetary regime.

In this article, I breifly discuss the three main monetary regimes of modern history: commodity-based money, representative money, fiat money - and what is already in the process of coming next.

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What is Money?

In practical terms, money is two things:

1. A means of exchange

2. A store of value

As a means of exchange, money can be used by individuals, businesses and governments to purchase goods and services. This is the most straightforward use – and one we are all familiar with.

As a store of value, like our cash savings, money that we don’t need to spend immediately can be stored so we can purchase goods and services with it in the future. This is currently being tested though, as we’ve now entered an environment of high inflation and low interest rates. More on that later…

Money as we know it, like so much of civilization as we know it, originated in ancient Mesopotamia (now Iraq) around 5,000 years go. This was the Shekel – and it is widely regarded to have been the first real currency used by humankind.

Where beads, or other rare/valuable objects were not used as proto-money, people often just exchanged goods and services directly with each other in what was known as the barter system. The origins of the barter system go much further back than recorded history, as it likely developed among our ancient ancestors, Homo Neanderthalensis, who went extinct some 40,000 years ago.

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The Three Main Types of Money

If you’ve ever traveled overseas, you’ve probably checked the exchange rate between your local currency and that of the destination country. You will probably also have noticed how that value changes over time. Sometimes it changes quite quickly.

It wasn’t always this way though. While the following is not exhaustive (or even remotely complete), it’s provided as a very basic roadmap for how we got to where we are today.

Commodity-based money: The first recognizable monetary system was commodity-based money, in which legal tender had a inherent value because it was made from a particular metal, like gold or silver, copper, or lead. Under this system, the value of a unit of currency is tied directly to the material from which it is made. Remember all those stories of sunken pirate ships, filled with gold coins? Well, this is why were there were so many gold coins – and one of the reasons why those gold coins weren’t particularly practical as money.

Representative money: This consisted of legal tender (metal coins and paper banknotes) which had no intrinsic value, but were backed by deposits of gold or silver. While this system is functionally similar to commodity-based money, it doesn't need to be linked to any specific commodity and abolishes operating costs. If you’ve ever used the term ‘Gold Standard’, this is what you’re actually referring to; the idea that something that isn’t made from gold, is pegged to the value of – and is backed by - physical gold.

Both of these were abandoned in different places, at different times, over a period of centuries – and for a number of different reasons. These reasons mostly boiled down to the idea that under conditions such as wars, economic crises, or pandemics, more money was needed than could be minted from available precious metals, or could be backed by physical reserves. This limitation has led to many governments throughout history occasionally ‘print’ more money than they could back with physical reserves, thus ‘debasing’ their currency. Rarely has this ended well. Overcoming the limitations inherent to commodity-based and representative money thus became an important priority for governments and central banks.

Fiat money: Finally, we have fiat currency - the most common monetary regime in use today. This type of money has no intrinsic value and derives its worth from government decree or law (hence "fiat", which means “be it” in Latin). Fiat currencies are the most readily exchangeable (ie. the most ‘liquid’) form of money because they can easily be converted into other currencies at a floating exchange rate, which is set mostly by supply and demand, instead of being fixed to the value of an underlying commodity. Importantly, this type of money can be created out of thin air, essentially without limit, by the nation state that issues it. They can do this because there is no requirement for it to be backed by, or representative of, any physical asset. The US, among others, has been taking full advantage of this (see below).

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The current system of floating exchange rates, also known as the Jamaica system, so-named due to the Jamaica Accord, was ratified by the International Monetary Fund in Kingston, Jamaica in 1976. This accord formalized the ability of most currencies of the world to change in value relative to one another. It basically covered for the fact that representative money ended in 1971, when President Richard Nixon famously abandoned the Gold Standard.

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The Future: Central Bank Digital Currencies

One way or another – and in the absence of some worldwide cataclysm which returns us to shiny beads and the barter system – the future is undoubtedly digital.

This does not mean that the future lies among the zoo of cryptocurrencies which are currently the subject of wild speculation, fads and scams. The future, in all likelihood, lies in nation states issuing their existing currencies as digital tokens.

Enter the Central Bank Digital Currency.

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A CBDC is simply a digital version of the fiat currency issued by a nation state – and it is envisaged that they will eventually replace all other forms of legal tender (eg. coins and paper bank notes). There are several reasons why governments may find this is so desirable:

1. Transparency: those involved in illicit activity and/or tax evasion in particular love dealing in cash because it’s mostly untraceable. In a system where every transaction – and every amount held - is visible to law enforcement and taxation authorities, the level of misconduct may be substantially reduced.

2. Control: One of the main reasons why many governments will likely follow in China’s footsteps by banning cryptocurrency transactions is that by keeping money centralized, they can keep very tight control over monetary policy. It would be a mistake to underestimate the supreme importance of this. Monetary policy is the only thing that kept the global economy afloat during and after the Global Financial Crisis of 2008 - and during the worst of the COVID-19 pandemic. If anything, central banks will be looking for way to cement tighter controls, than be willing to outsource it.

3. Reduced Systemic Fragility: Payments made in CBDCs will not have to pass through as many hands as payments made in the current monetary system. Being essentially a direct line between the central bank and consumers and businesses, the risk of intermediary failures (like bank runs, or bank collapses) may essentially be eliminated.

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There are several reasons why many find the idea of CBDCs undesirable though. Firstly, they invite the risk of removing what little financial privacy we have left. Furthermore, there are currently no, or very few, regulations and rules in existence to define how CBDCs will work – and how regulators and tax authorities will interact with us. This creates an opportunity for governments to grant themselves sweeping new powers, which I’m sure many will take full advantage of.

You probably wouldn’t want to be an undocumented immigrant in a world of CBDCs…theoretically, you’d have no way to get paid, or to buy anything. If you aren’t a legitimate participant in an economy – and willing to use the CBDC payment system - you may risk finding yourself completely frozen out.

One slightly spooky implication of that CBDCs is that they may make it easier for a single, global currency to emerge. It’s not difficult to imagine a need for this in the midst of a particularly nasty global crisis, especially with so many major currencies bending under the weight of prior transgressions. I’ll leave that for another day…

Regardless of any objections, I think we can be quite confident that this is going to happen – and soon. Most of the world’s major economies are now either researching, or piloting, their own CBDCs (see below).

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Looking Forward

From barter, to beads, to banknotes and beyond, the many-thousand year journey of money may now be approaching it’s apex.

This is not the end of the story by any means, but it seems almost inevitable that CBDCs will become the dominant form of money within our lifetimes, perhaps even by the end of the current decade.

For most people, this won’t be uncomfortably different to how things are done now. After all, it’ll still (probably) be fiat money – and you’ll still be able to spend it from a card, or mobile device.

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I sincerely hope you like it too, because not using it is very unlikely to be an option...

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