Sometimes, it can be difficult to grasp why money has value. Yes, you use it to buy things, but why can you use it to buy things? To try to answer that question, we should go back in history and answer – what is commodity money?
Monetary and economic systems evolve over time, but they are all built atop one another. So, to truly understand how the current fiat money system works, we need to understand what it evolved from.
And that is what we will discuss in this article – we will talk about commodity money, how it is different from other monetary systems, and provide examples. We will also show that commodity money is not just a historical artifact but still has practical use today. So let’s get started.
Commodity money is a form of money that has inherent, intrinsic value because it is made from a commodity that has value by itself for production or consumption. Commodity money is a physical asset - you can see it, hold it, touch it.
In simpler terms, gold coins were commodity money because the gold from which the coins were made had intrinsic value and if the coins were melted down, the gold would still retain its value. The gold could also be used for production, i.e., making jewelry, giving it its intrinsic value.
But we should backtrack a bit here – what is money? Money can be defined as an asset that is accepted as a medium of exchange for goods or services. The value of that asset can and was determined by many different factors but it often boiled down to a commonly recognized value by the people that use it.
In that context, there are three primary categories or types of money (the latter 2 will be discussed in more detail later):
Popular examples of commodity money throughout history were gold, silver, and copper, cocoa beans, shells, tea, barley, furs, and even cigarettes. Clearly, people exchanged all types of commodities for goods or services. Then, how is commodity money different from bartering?
Bartering is an exchange system where goods are exchanged for other goods or services. The value of the items that are being exchanged is determined by the people participating in the trade. So, if an ancient cattle farmer was to give a calf to a carpenter in exchange for a table, that would be bartering.
But the system of bartering has several limitations. For one, it is difficult to transport different types of goods across large distances, making it impractical. Second, there is no set ‘exchange rate’ or how the value of one asset converts to all other assets.
Third, many goods cannot be divided into smaller parts, making smaller trades or more accurate exchanges difficult. Finally, many goods are also perishable, which disallows them to be a store of value. So, bartering faced 4 challenges:
To make trade more effective, the concept of commodity money evolved. A single type of asset that was portable, divisible, and non-perishable would be chosen and used to trade for other goods and services at an agreed-upon exchange rate.
Thus, the key difference between barter and commodity money is that commodity money uses a single recognized unit of exchange to purchase goods or services.
To reiterate, commodity money is money that has intrinsic value due to the commodity of which it is made. But there are also two other primary categories of money:
To simplify, commodity money is made from a physical commodity and has intrinsic value, representative money has no intrinsic value but represents a commodity that has intrinsic value and can be redeemed for it, while fiat currency has no intrinsic value and does not represent a commodity but is given value as a unit of exchange by the institution that issues it.
The most common example of commodity money throughout history is the use of metal coins, like gold, silver, or copper. Silver coins based on the Spanish dollar are likely the best example of commodity money in the Americas.
But that is far from the only example of the use of commodity money. For instance, beaver pelts were the main unit of exchange in the area around Hudson’s Bay in Canada for fur traders in the 18th century.
This system came about because the First Nations were not interested in exchanging goods for precious-metal coins, so they needed to find another medium of exchange – the beaver pelts. They even had an exchange rate set up, e.g., 5 pounds of sugar were worth 1 beaver pelt while 1 gun cost 12 beaver pelts.
Eventually, even that commodity money system evolved. For convenience, Hudson Bay post managers started issuing stamped copper or brass tokens in different sizes – these were called made beaver coins. The largest token represented the pelt of one adult male beaver in good condition. The smaller tokens represented smaller pelts. Thus, the commodity money system of the fur traders evolved into a combined commodity and representative money system over time.
In modern times, it may seem like commodity money is a historical occurrence, given that almost all countries use representative or, more commonly, fiat money. But that is not the case – commodity money can exist alongside other money categories.
Cigarettes are a common form of commodity money when other types of currency are prohibited. For example, they were often used in prisons in the US as a unit of exchange before smoking was banned in prison in the early 2000s.
While the line where a commodity becomes a currency can be debated, generally speaking, whenever a single commodity is recognized by a population as a unit of exchange for goods or services, it can be considered commodity money.
Although commodity money still sees use in specific instances, the primary medium of exchange for goods or services in the current era is fiat money. And US First Exchange can help you exchange it. With us, you can buy or sell over 20 different currencies, including exotic ones like the Iraqi dinar or Vietnamese dong.
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