The Origin of Money

Abstract：Money, at its core, addresses society's need for coordination and cooperation. Its utility lies in universal acceptance, as explained by Carl Menger, likening money to language in its spontaneous evolution. Money overcomes the inefficiencies of barter systems by eliminating the "double coincidence of wants," reducing quality assessment costs, and significantly increasing transaction volumes. Its value is not intrinsic but rooted in trust and mutual recognition. Historical examples, like Pacific island stone money, highlight its abstract nature. Nobel laureate Milton Friedman emphasized money's profound impact on economies and societies, illustrating its essential role in human progress and coordination.

The entire study of macroeconomics revolves around money, with its core question being how society achieves coordination and cooperation through the use of money. Let’s explore this concept step by step.

1. Why is Money Useful?

Money—undoubtedly useful, isn’t it? While we take its utility for granted, philosophers have historically debated its value. For instance, Aristotle claimed, "Money is barren," implying that money itself cannot generate anything of intrinsic value.

However, money's widespread and enduring use contradicts such notions. Even in extreme environments like prisoner-of-war camps, makeshift currencies have emerged. Why does money persist?

In his 1892 essay On the Origins of Money, Austrian economist Carl Menger explained that money's utility lies in its acceptance. If people believe money has value and are willing to accept it, it becomes effective. Menger compared the development of money to language: just as a word gains meaning through shared understanding, money functions through mutual acceptance.

This idea aligns with the Austrian School's concept of spontaneous order. Social structures like language and money arise organically through countless individual actions rather than centralized design.

2. The First Function of Money: Overcoming the "Double Coincidence of Wants"

Money's primary utility is eliminating the double coincidence of wants required in a barter economy.

Imagine in a barter system, you have bread but need milk. To trade successfully, you must find someone who not only has milk but also wants bread—a rare dual alignment.

Money simplifies this process. You can sell your bread to anyone willing to pay in money and later use that money to buy milk from anyone selling it. This flexibility greatly enhances trade efficiency.

To illustrate, compare trade to romantic relationships: successful relationships require mutual affection, a "double coincidence." If a "love currency" existed to convert admiration into reciprocal affection, relationships might become simpler—but alas, love operates as a barter system.

3. The Second Function of Money: Reducing Quality Assessment Costs

Money also reduces the need for quality checks during transactions. In a barter system, a baker trading bread for meat must assess the quality of the butcher's goods. Similarly, trading bread for wine requires evaluating the wine's quality.

With money, you only need to verify the currency's authenticity. This simplification significantly reduces transaction costs.

4. The Third Function of Money: Increasing Transaction Volume

By eliminating the double coincidence requirement and halving quality assessment costs, money exponentially increases transaction volume. This, in turn, enhances societal well-being.

Historically, societies have used diverse items as money, including livestock, salt, rice, metals, and even stones.

5. A Story of Stone Money

On a Pacific island, residents used large stones as currency. Wealth was visibly displayed outside homes, with the wealthiest family owning a massive stone at the bottom of the sea. Though it couldn’t be retrieved, everyone acknowledged its value, demonstrating the abstract nature of money.

When German colonizers demanded road construction, they confiscated the stones by marking them as their own. The locals, fearing the loss of their wealth, complied. Once the roads were built, the Germans erased their marks, restoring the stones to their original owners.

This story parallels historical monetary systems tied to gold and silver reserves. For instance, in the early 20th century, France demanded the return of U.S.-held gold, prompting a symbolic exchange of ownership tags. Such practices reveal money's reliance on trust and perception.

This fascinating journey of money—from its origins to its essential functions—illustrates how it underpins societal coordination and cooperation. As Nobel laureate Milton Friedman emphasized in his book Money Mischief, the story of money is deeply intertwined with human history, shaping economies and lives alike.