By Jonny Lupsha, Wondrium Staff Writer
The first known currency, the Mesopotamian shekel, dates back 5,000 years. Since then, people have used everything from furs to salt to livestock as money. How did modern currency come about?
Over the millennia, new forms of currency have been introduced to civilizations around the world. In ancient Mesopotamia, the shekel—meaning one-third of an ounce of silver—was a coin that became the first currency. Later, ancient civilizations in China, India, and Egypt used gold, silver, and bronze coins to purchase goods and services. Paper money followed in the 1800s, while the 21st century has seen the rise of contactless credit card payments and cryptocurrency.
Beginning with paper money, how did the world arrive at its modern state of currency? In his video series Macroeconomics Made Clear, Dr. Akila Weerapana, Associate Professor of Economics at Wellesley College, recalls the last two centuries of the evolution of money.
Why Do People Use Paper Money?
“Beginning around the 1800s, paper notes began to be used as money and soon began to overtake the use of coins,” Dr. Weerapana said. “Paper money was easier to produce, transport, and divide, but had the obvious drawback of not being a commodity—There was no intrinsic value of the note itself.”
People had to be comfortable using a small piece of paper in an exchange. They had to know it had some kind of backing or value. To do so, governments began limiting the supply of paper currency that could be printed, and they limited it to a commodity like gold or silver. Until the early 20th century, many countries used the gold standard, fixing the price of gold in terms of paper money.
In the United States, the price of gold was set to $21 an ounce. The gold standard collapsed in 1933 and was replaced by the Bretton Woods system.
“The Bretton Woods system that began in 1945 was based on gold and the U.S. dollar, at a time when the United States controlled two-thirds of the world’s gold,” Dr. Weerapana said. “Technically, the United States dollar was fixed to gold at a price of $35 per ounce, but this rate became increasingly difficult to maintain over the 1960s as the money supply of U.S. dollars increased, creating a mismatch between the price at which gold could be bought or sold on the world market and the rate at which dollars could be converted to gold through the Bretton Woods system.”
The United States ended dollar convertibility into gold in 1971. Other nations soon followed.
What Is Liquid Currency?
These days, fewer and fewer people use cash to pay for transactions. Most of what we think of as “money” is deposits at banks, credit unions, and so on, which we access directly with various instruments like checks, debit cards, and payment apps like PayPal or Venmo. This eliminates the need for converting that money into paper currency at a bank or ATM.
“In the modern economy, money gets categorized by the Federal Reserve according to how liquid it is—that is, how easy it is to use in transactions,” Dr. Weerapana said. “Prior to May of 2020, the official categorizations were M1, which defined currency and checking account balances held in banks by individuals and firms, as well as traveler’s checks, and M2, which was defined as everything in M1 plus savings deposits, time deposits, […] and other deposits where check writing is limited.”
Generally, the distinction between the two is that items in M2 that are not in M1 aren’t as liquid, or easily accessible and convertible, as those in M1.
Since mid-2020, the Federal Reserve removed a restriction on the maximum withdrawals per month that an individual could make on a savings account, making savings accounts much more liquid. This recategorized savings accounts into M1 territory, thus, dramatically tipping the scales.
Macroeconomics Made Clear is now available to stream on Wondrium.