The Origin of Money

Austrian Political Economy

Austrian Political Economy

I write about economics and political philosophy.

 

Nearly everyone appreciates how vitally indispensable money as a common medium of exchange is for society. It allows for an extensive division of labour and large-scale production and is a necessary prerequisite for economic calculation. In short, money and civilization are inextricably linked. It is impossible to have civilization without money. 

But how is that money came about? One possible explanation of the historical origin of money

is that a wise ruler envisaged the immense benefits of money and therefore ordered his subjects to adopt whatever good he decreed was to be money as a medium of exchange. 

This is an inadequate theory for a number of reasons. First, as Menger explained, there exists no historical evidence of such an event ever taking place. Every historical civilization was a monetary society yet archaeologists have not found any trace of their rulers ever “inventing money”. 

Secondly, it is unlikely, though not impossible, that someone could come up with the idea of money without ever being exposed to it themselves.  

In his 1892 book, On The Origins of Money, Carl Menger, the founder of the Austrian School, expounded a different theory. According to Menger, money was not the product of a government edict, but rather arose spontaneously in the market as a result of the purposive actions of self-interested men.

“Money has not been generated by law.” Menger wrote, “In its origin, it is a social, and not a state institution. Sanction by the authority of the state is a notion alien to it.”

Money is an example of what Hayek called “spontaneous order”. It is a complex social institution that, to quote the Scottish Enlightenment philosopher, Adam Ferguson, is the “product of human action but not of human design”.

The theory proposed by Menger not only avoids the aforestated problems but also provides the most comprehensive and coherent explanation of the origin of money. 

Menger explained that extended indirect barter exchange would inevitably generate money. In order to understand how this happens, we need to first define indirect exchange. An individual engages in an indirect exchange when he accepts a good in trade not because he wishes to use it directly (in consumption or production), but because he wishes to use it as a medium of exchange as a means to obtain goods he does desire for direct use in subsequent exchange transactions.

Over time, the more saleable goods would see a major increase in their marketability as more and more people who didn’t desire the goods for their direct use would nevertheless be prepared to accept them in trade because of their saleability as a medium of exchange. 

The logical conclusion of this process is that certain good(s) would outstrip all others and become universally accepted in trade. This would mark the emergence of money on the market. 

Throughout history, the most prominent forms of money have been gold and silver. To understand why these precious metals frequently arose on the market as money, we can state some of their properties, namely (1) divisibility (2) ease of transportation (3) durability, and (4) high market value. 

In light of these practical considerations, it is plain to see why gold and silver are ideal candidates for money. They are divisible, easy to transport, significantly durable, and command a high market price due to their high marginal utility. 

Now, it is not the case that Austrian economists are gold and silver zealots who contend that gold and silver are the only “natural” forms of money; they simply explicate using sound economic reasoning why, historically, gold and silver emerged on the market as the dominant forms of money. 

Menger’s exposition is a testament to what can be achieved in the realm of economic theory by employing the verbal logic and methodological individualism of the Austrian School. Any economist who wishes to undertake a fruitful economic analysis of money must first understand Menger’s explanation of its origin. 

Bibliography 


Menger. 1871. On The Origins of Money

Rothbard. 1962. Man, Economy, and State.