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.
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:
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
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:
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".
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
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
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.
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:
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.
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
(3) Representative Money:
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.