Investing Fundamentals

Money History: The Creation Of Money

Updated on August 16, 2019 Updated on August 16, 2019
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Money History

It’s something we use every day and something that has been in use for millennia. But how often do you think about the history of money? It turns out; money history is pretty fascinating. Some form of money is even more vital to civilization than some form of writing, so humanity created different monetary systems early on.

When we think of money today, we think of paper currency, metal coins, credit cards, and even cryptocurrency, but those forms of money have only been around for a fraction of money history.

history of money

And as other forms of currency have come and gone, the forms we use today could one day be replaced. If we continue to ignore the impact of climate change, it’s possible the most valuable form of currency in the future will be livable land or water.

But how did we get here? Is it true cowrie shells were once a form of currency or is that an urban myth? Which society used the first coins? What makes any form of money legal tender? Can someone refuse to accept your money as a valid form of payment? Is there really gold in Fort Knox?

According to the Bureau of the Fiscal Reserve, there are 147,341,858.382 ounces of gold in Fort Knox as of August 31, 2018. The gold is held as an asset of the United States at a total book value of $6,221,097,412.78. This gold is primarily in the form of gold bars.

We’ll answer these questions and more as we delve into the fascinating history of money.

The History of Money

Get into your Way Back machine or TARDIS, the evolution of money spans centuries.

The Dawn of Time

As long as humanity has been living in social groups, we have used some form of currency. Before we were sophisticated enough to assign a face value to a hunk of metal or a piece of paper, we still had to find a way to get something from someone else that we couldn’t get for ourselves. Taking it by force is one way but doesn’t really make for a harmonious society, so we had to figure out Plan B.

Bartering was the first form of currency, first recorded in Africa, specifically Egypt in 9000 BCE. People would trade what they had a surplus of for things they didn’t have. Grain and farm animals were among the most common items used for bartering.

Every economics textbook will tell you that money evolved to make the barter system more efficient because people were tired of chopping goats into quarters to pay for people to mow their lawn.

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The next step in the evolution of money was cowrie shells. Yep!  They actually were a form of currency in regions clustered around the Indian Ocean around 1200 BCE. These shells were a precursor to silver coins.

The first record of an officially minted coin is around 546 BCE in Lydia which is in what is Turkey today. China gave us the first gold coins during the Qin Dynasty, which lasted from 221 to 207 BCE. After the end of the Qin Dynasty, Han emperors created the first form of paper money in the form of notes made from deerskin.

The deerskin notes were a welcome development as they’re so much lighter to carry than gold or silver coins. The first paper notes were created in the 7th Century by the Chinese. Paper money was first introduced to Western countries by Marco Polo.

evolution of money

The first banknotes came from Sweden in 1661.

The Problem With Paper Money

Paper currency solved the problem of having to carry around heavy metal silver and gold coins, but it created a whole host of new issues. In its infancy, most countries had no laws stating who or what could print money.

Thanks to Gutenberg, anyone with a printing press could print money. There were some counterfeiting laws, but counterfeiting laws didn’t cover people deciding to issue their own, bespoke money!

You can imagine the results. If anyone could print money, money had no value. At the time, whether or not paper money had value depended on how much people trusted the issuer and if it had coin backing.

And since there was no central bank issuing accepted currency, people were free to accept paper notes or not. Of course, if a currency isn’t recognized as a form of payment, it has no value.

Enter the Central Bank

Central banks were created to deal with the problems of unregulated currency.

A central bank also acts as the regulatory authority of a country’s monetary policy and is the sole provider and printer of notes and coins in circulation.

The first central bank was British, the Bank of England established in 1694 but the modern central bank as we know it didn’t come about until the 20th Century. In the United States, our central bank is the Federal Reserve.

The Federal Reserve came about in response to the Panic of 1907. Over a span of three weeks, the market collapsed, stock prices tanked, and there was a run on banks. The Treasury, with the help of J.P. Morgan and other Robber Barons, pumped $30 million of aid into the void to channel money from solvent banks to collapsing banks to restore public confidence in the financial markets.

In an effort to prevent similar crises in the future, the Owen-Glass Federal Reserve Act was created it 1913, and the Federal Reserve was born.

What the Federal Reserve Does

The Federal Reserve (Fed) has three parts:

  • The Federal Reserve Board of Governors is seven board members who oversee the Federal Reserve System.
  • 12 Federal Reserve banks across the country that handle the administrative work of the Fed. Located in major cities including New York, Boston, and Chicago.
  • The Federal Open Market Committee (FOMC) is the Board of Governors and five Reserve Bank presidents who set monetary policy.

The Fed’s job is to create a robust economy through its monetary policy. How does the Fed define a healthy economy? Low unemployment and low inflation. The Fed oversees and regulates banks and other financial institutions to create stability in financial markets.

Most surprising to me was that the Fed provides payment services. It makes sure there is enough physical currency in circulation, clears checks and processes electronic payment transactions, is the U.S. government’s banker and maintains the Treasury Department’s checking account, and processes Social Security payments and government payroll.

The Gold Standard

The Gold Standard Act became law in 1900, which established gold as the sole basis for redeeming paper currency. It set the value of gold at $20.67 an ounce, and the dollar valued at 25.8 grains of gold.

the gold standard

Many countries adopted the gold standard, but those in Europe suspended it during World War I to print enough money to fund their military. This overprinting of money created hyperinflation. This showed the importance of pegging currency to gold, and many European countries adopted a modified gold standard.

The problem with the gold standard is that when used, the size and health of a country’s economy depends not on the success of its workforce but on its supply of gold. In 1933 there was a run on gold reserves held by banks.

These two factors caused FDR to close the banks and only allow them to reopen on the condition that they turned over their gold to the Federal Reserve. FDR also orders Americans to exchange their gold for dollars; this is where all that gold held in Fort Knox came from. This switchover creates $11 billion in currency out of thin air.

This wasn’t the end of the gold standard, though. It hung around until 1971 when Nixon declared the Fed would no longer be allowed to redeem dollars with gold, making the gold standard meaningless.

Where Money Comes From

If precious metals no longer back the pieces of paper in your wallet, what gives them value? Nothing apart from the unspoken pact, we all have that those pieces of paper have value and exchange them for everyday goods and services.

The Fed creates money out of thin air in exchange for government debt (bonds and notes). Company X asks the Fed for $10 million. All the Fed does is add a bookkeeping entry to its ledger and viola! A check goes out to Company X, and the Fed gets a bond.

And that’s what most of our money is, entries in a ledger. Only about 3% of our currency is tangible paper and coins. This is a debt-based system. Money (debt) gets created, and interest gets paid. To pay the interest, the money supply has to keep expanding to perpetuate the modern banking system.

At a minimum, every year enough new money has to be loaned into existence to cover the interest payments on the previous years. By design, this system is exponential, and the amount of debt will always exceed the sum of money.

What All of This Means to You

Okay, the part about first coins and first paper money were interesting, but the rest is all Greek to most of us. What does the history of money have to do with personal finance?

From the time the United States wasn’t yet the United States but a collection of colonies up to 1973, the U.S. created $1 trillion (well short of the amount of student loan debt we have outstanding at $1.5 trillion to put the student loan debt crisis in perspective). In 2008, it created $1 trillion in four and a half months.

We create money faster and faster, and that creates inflation. When salaries don’t keep up with inflation, it eats away at the value of people’s savings. Every time a new dollar gets created, it reduces the value of already existing money.

This is why we tell you that you have to get over your fear of investing. You think your money is safely tucked away in that savings account where it’s earning almost no interest. But when the rate your money earns is less than the rate of inflation, your money loses value.

Its purchasing power determines the value of a dollar. When inflation increases, the purchasing power of our dollar decreases. The average rate of American inflation over the past ten years has been just under 2%. That means the cup of coffee that costs $1 now will cost $1.02 next year.

Even most high yield savings accounts don’t pay much more than 2%. By keeping your money in such an account, the interest your dollars make is not even to outpace inflation, and your dollars become worth less and less.

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Here’s the Solution

The monetary system we operate under requires you to subject your money to some risk; otherwise, it loses value. This is the reason we encourage everyone to overcome their fear and start investing.

Because while we all fear losing money, those afraid to invest are fearing the wrong thing. Conservatively, you can expect an annual return of 7% over time when you invest your money, well above the average rate of inflation.

So let go of your fear of investing and realize the real danger is doing nothing.

Show Notes:

Debt – Book by David Graber

U.S. History of Money

Video On Money Creation

Fractional Reserve Model

Modern Money Mechanics

Candice Elliott - Editor-in-Chief
Candice Elliott is a substantial contributor to Listen Money Matters. She has been a personal finance writer since 2013 and has written extensively on student loan debt, investing, and credit. She has successfully navigated these areas in her own life and knows how to help others do the same. Candice has answered thousands of questions from the LMM community and spent countless hours doing research for hundreds of personal finance articles. She happily calls New Orleans, Louisiana home-the most fun city in the world.
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