What Is Money, Part 2

Welcome back to our series, "What Is Money?" In our first post, we began exploring the profound impact of money on our lives, our families, and even the future of humanity. We discussed how, despite its crucial role, many of us don't fully understand what money actually is (you can read it here). To gain a clearer understanding, we emphasized the importance of delving deeper into the essence of money, rather than just its functions.

🔄The Barter System

Now, to truly grasp what money is, we need to explore its origins. Today, we'll dive into the historical context of money, starting with the barter system. To answer the question of what money is, we must first look at what it has been. 

The earliest economies were simple barter systems where participants engaged in the direct exchange of goods and services. People traded items of inherent value, like cattle or grains, based on what they had and what others needed. For example, a blacksmith might trade his services shoeing a farmer’s horses for some beef from that same farmer’s cattle.

💵Functions of Money

In this simple economy, there was no need for money. In a barter system the goods and services themselves were exchanged, value for value. This is known as the double coincidence of wants and occurs when two parties each have something the other wants, and they agree on the value of these items, making an exchange possible. As the economy grows in complexity, this direct trade of value for value becomes more and more difficult. 

For example, what happens when a farmer needs a new barn, he has livestock to trade, but the carpenter doesn’t need livestock at this time. Maybe there’s an attorney who does need some livestock, and the carpenter needs some legal services. However, the carpenter doesn’t want to trade his livestock, and the attorney doesn’t need the services of the carpenter. And who’s to say that all of those goods and services balance out to approximately the same value. This can get pretty complicated pretty quickly. It would actually be simpler if the participants in the economy had an item that could be easily held and exchanged by everyone to purchase the goods or services they need. This item would act as money, and as such must serve three primary functions: 

1) Medium of exchange 

2) Unit of account 

3) Store of value.  

A medium of exchange is anything widely accepted for goods and services. This medium has an agreed-upon value, also known as a unit of account. A unit of account is like a common measuring stick for value, helping people determine how much one item is worth in relation to another. This also makes it possible to accumulate and combine various amounts of the item to purchase different amounts of goods or services. Finally, the value can be preserved if one holds the item until they need to make a purchase, making it a store of value. These are the three most fundamental functions of money. 

Already, from this simplest of economies, a barter system, we’ve identified the need for an item that fulfills these three functions. While more information is needed to fully answer the question, what is money, this is a good place to pause and dig a little deeper. That is because what money is and what its functions are, while related, are not one and the same.

💎Money Is Time

Before we move on from the barter system let's identify what is really being bought, sold, or traded. At first glance, it may seem obvious: chickens, a side of beef, flour, boot repairs, clothes, or a new wagon wheel. On the surface, this is true, but what these goods and services represent is what truly matters.

Each of these goods and services fundamentally represent time and energy. Time is a scarce resource. Early in life, it seems like we have time in abundance and there will always be more, but as we age, we realize this isn't the case. Each of us has a finite amount of time. This makes time both precious and non-renewable. Once spent, time cannot be reclaimed, which is why our choices on how we use it are so important. Whether we invest it in work, leisure, learning, or relationships, our time is always scarce and therefore valuable.

In this context It's important to recognize that we're not only talking about the immediate time spent growing, tending, or delivering a good or service. We must also consider the time invested in learning and honing the craft. The quality of a good or service is proportional to the time spent understanding, practicing, and perfecting it. Mastery involves trial and error, and those who have invested significant time to develop their skills are able to create something of even greater value than those who haven't.

🔋The Role of Energy in Value Creation

By energy, I literally mean calories. I am referring to the physical and mental effort, powered by the consumption of food and water, that a person uses to perform tasks over time to produce things which are valuable and/or desirable. Whether it is raising a chicken from an egg to one that lays eggs, growing corn from a seed to many ears of corn, or learning to tan a hide and work with leather to form it into the shape of a shoe that sits comfortably around a person’s foot, they are expending energy in the form of calories burned to use their body and mind to develop something of value. And the calories consumed to generate this energy are the result of the investment of time and energy in the past so we can do work today. 

While demand, quality, scarcity and market conditions contribute to the value of a good or service, the investment of one’s time and energy also play an important role. Without it, the good or service would not exist. 

 🌱The Birth of an Economy

In any scenario we can imagine in a simple bartering system, at the foundation are individuals who get up every day to build, make, farm, learn, practice, and improve. Once they have expended enough energy and time, the desired good or service they create becomes valuable—a contribution to society and humanity, something that pushes back against entropy, quite literally making the world a little bit better. By investing these resources to create what others need and want, they encourage others to trade what they have accumulated with their own time and energy for these valuable creations. This is how an economy is born.

As we’ve seen, early economies relied on the direct exchange of goods and services through barter, highlighting the intrinsic value of human labor and skill. This foundational concept is key to understanding economic progress. In our next post, we’ll delve into how these early exchanges evolved into the use of a variety of items serving as money, eventually leading to the development of coins and paper currency and revolutionizing economies and societies. Stay with us as we uncover the journey from barter to modern currency, and discover how these historical developments continue to shape our financial world today.