With the passage of time the barter system lost its efficacy. Hence it was thought for some commodity which could be used to represent the values of goods and services. Moreover such commodity could be acceptable to the trading parties with out any hesitation. With such realization, the evolution of money started, which is presented below:
(1) Commodity Money Standards:
In the very initial stage the commodities like arrow, sword, knife, salt hides, cows, wine, wings of the birds, elephant teeth and slaves were used to make transactions. As in ancient Rome the salt and cattle were used as money. Tobacco was used as a medium of exchange in American colonies. While in certain other areas of the world the “pegs” were used to exchange the goods. But such commodities lacked the essential properties of money, as:
(i) In that period there did not exist any commodity which had general acceptability as a medium of exchange.
(ii) The good serving as money, should have the quality of divisibility. But the cattle lacked it. The cow would fail to maintain its value once it is slaughtered.
(iii) The good which is to serve as money should easily be transported from one place to the other. But the pegs were not good money because of inconvenience attached with their transportation.
(iv) The essential quality of money also requires for durability. But the commodities like salt, sugar, tobacco, vegetables and milk were not durables, their value may deteriorate.
(2) Metallic Money Standards:
Because of shortcomings attached with commodity standard the new development in history of money is given the name of metallic money standards. In this respect the iron and copper coins were used as money. Such metals were used as money because of their scarcity But with the passage of time the mining technology became popular and the scarcity of metals came to an end. The abundance of iron and copper led to decrease their value. Therefore, the period of iron and copper coins came to an end, and the period of bimetallism stoned.
In the very beginning gold was expensive and there was a dearth of gold. Moreover, the people had such a low incomes that it was difficult to use gold for day to day transactions. While on the other side the silver was in abundance, it was cheap and its coins could be used even for minor transactions. Afterwards in 19th century the gold deposits were discovered in Australia and California. As a result the supply of gold increased. With this the period of bimetallism stoned where the Gold and Silver coins were used as money. Under this metallic standard, the official price of silver in terms of gold was determined. As during 1772 to 1834 in US the price of one ounce of gold was 15 ounces of silver. But the major shortcoming of bimetallism was identified by Sir Thomas Gresham. In this respect, he presented his law known as “Law of Gresham”.
Law of Gresham:
Sir Thomas Gresham was financial advisor to Queen Elizabeth I. His life span was from 1519 to 1579. Gresham Law is as:
“Bad Money Drives Out Good Money”.
Thomas Gresham told the Queen that those coins which were highly valued in terms of silver coins people had dropped them using as a medium of exchange. In this way, the more valued coins (gold coins) have gone out of circulation while those coins which were less valued in terms of silver coins remained in operation to be used for transactions. The reason behind this was:
Henry VIII, who was father of Queen Elizabeth I decreased the proportion of pure silver in the silver coin from 92.5% to 33%, but he did not lower the face value of such coin by the same percentage. In this way, the silver coins emerged as “Bad Money”, and gold coins were considered as “Good Money”. Consequently, the coins whose real value did not decrease (gold coins) were collected by the people. The silver coins remained in circulation and gold coins went on getting out of circulation. There is another explanation of ‘Law of Gresham’:
As there was an official price of gold in terms of silver, i.e. one ounce of gold was equal to 15 ounces of silver. But in addition to such official price, there also prevailed an unofficial rate of exchange between gold
and silver. This rate of exchange was determined on the basis of supply of silver in the open market. If at any time there is excess supply of silver the price of silver will fall. It may happen that the price of silver in terms of gold goes up to 16 ounces. In order to earn profit people will take away the gold coins from circulation. By melting a gold coin the holder will be able to get 16 ounces of silver. When the profit motive of earning an extra ounce of silver will be existing the gold coins will be getting out of circulation which represent good money. Accordingly, the Bad Money (silver) will remain in circulation, and the Good Money will be out of circulation.
Practically, law of Gresham was observed when official and unofficial prices of silver in terms of gold were witnessed. This paved the way for monometallic standard, rather bimetallism. Accordingly, Gold standard came into operation.
(ii) Gold Standard:
Under gold standard not only gold coins were used for transactions at domestic level, but international trade was also carried on the basis of gold. As in 1900 in US the gold standard, was in operation where the official price of gold was: $ = 25.8 grains of gold.
It means that by giving 25.8 grains of gold one dollar can be obtained; while with one dollar 25.8 grains of gold can be had. It shows that gold as a commodity and gold as a money were convertible with each other at official rate of exchange. This convertibility provided confidence in dollars; i.e. people could be able to get 25.8 grains of gold if they sold the dollar coin of gold after melting it. As in different countries of world there prevailed the gold standard, the international transactions were also carried out under gold basis. The exchange rate between dollar and gold was fixed, again the rate of exchange between pound and gold was fixed. As a result the international exchange rate between pound and dollar was also fixed.
The biggest advantage of gold standard was concerned with the stability in the value of currencies both at domestic and at world level. Because of such stability the people, businessmen and financial institutions were not worried of fall in the value of money. But gold standard was objected on the ground that it encouraged the outflow of gold when a country faced deficit in its balance of payments. In this way, the gold reserves of a country would be depleted creating a lot of problems for the country concerned. The outflow of gold will also have the effect of decreasing the supply of money at country level. This will create deflation making the domestic goods cheaper and foreign goods expensive. In this way, the BOP of a country may improve. But the deflationary tendencies may lead to create unemployment, fall in investment, bankruptcy of banks and unrest amongst laboring class. Moreover, when the outflow of gold continues, a shortage of gold will develop in the country leading to decrease the proportion of gold in the currency. In this way the confidence in the currency will shatter. Thus because of these demerits the gold standard could not maintain itself. After 1930’s when State Intervention got popularity Gold Standard collapsed both at domestic level and at world level.
(3) Representative Money:
Earlier we discussed commodity money, and we told that till 1930’s the gold remained in use as a money. But the gold as a money had to face a lot of problems, as:
(i) The gold coins were bulky and it was difficult to carry them.
(ii) The gold coins were easily identified, hence there prevailed a fear of being stolen away.
(iii) Because of increase in population, trade, large scale production and diversification in desires the demand for money went on increasing, but the supply of gold could not be increased to the desired extent With these problems the era of ‘Commodity Moneys’ came to an end and the representative money period was set in.