Commodity Money

Commodity money is money whose value derives from the commodity of which it is made, or from its convertibility into a commodity. Historically, commodities such as gold, silver, and copper served as money, and their value as money was linked to their value in other uses.

Characteristics

For a commodity to serve as money, it must possess several properties. It must be durable, so that it can be stored and used over time. It must be divisible, so that transactions of different sizes can be conducted. It must be portable, so that it can be transported. It must be recognisable, so that its authenticity can be verified.

Precious metals met these requirements and were widely used as money. Their scarcity and the cost of production limited the quantity that could be supplied, providing a natural constraint on the growth of the money supply.

Full-Bodied and Representative Money

Full-bodied commodity money consists of coins whose metal content is worth the face value. Representative money consists of tokens, such as banknotes or coins, that are convertible into a commodity at a fixed rate. In a gold standard, for example, currency is convertible into gold at a fixed price, and the money supply is linked to the gold reserves.

The distinction matters for the analysis of money and prices. With full-bodied money, the value of money is determined by the value of the commodity, and the quantity adjusts through production and through the flow of metal into and out of monetary uses. With representative money, the authorities can influence the quantity, subject to the convertibility constraint.

Advantages and Disadvantages

Commodity money has advantages, including the constraint it places on the creation of money and the confidence it inspires, since the value of the money is backed by a commodity. It also has disadvantages, including the resource cost of producing and storing the commodity, the dependence of the money supply on the availability of the commodity, and the difficulty of adjusting the money supply to the needs of the economy.

The gold standard, in particular, linked the money supplies of participating countries and transmitted monetary conditions across borders. While it provided stability in some respects, it also transmitted shocks and constrained the ability of countries to respond to domestic conditions.

Historical Evolution

The evolution of money moved from commodity money to representative money and then to fiat money, which has no commodity backing and derives its value from the credibility of the issuing authority. The transition reflected the advantages of fiat money, including the ability to manage the money supply and the savings in resource costs.

Despite the dominance of fiat money, commodities continue to play a role in the monetary system. Gold is held as a reserve asset, and commodity-backed instruments are used in some contexts. The analysis of commodity money informs the understanding of the functions of money and of the design of monetary systems.

The Gold Standard

The gold standard is the principal historical example of commodity money. Under the standard, currencies were convertible into gold at fixed rates, and the money supply was linked to gold reserves. The standard operated in various forms from the nineteenth century until the early twentieth century.

The standard provided a nominal anchor and facilitated international trade by reducing exchange rate uncertainty. It also constrained monetary policy, since the money supply could not expand beyond what gold reserves permitted, and it transmitted monetary conditions across countries.

Bimetallism and Coinage

Bimetallism is a monetary system in which two metals, typically gold and silver, serve as the standard, with a fixed ratio between them. The system was used in several countries and was the subject of political debate, particularly in the United States in the late nineteenth century.

The maintenance of a fixed ratio between the two metals proved difficult, since changes in the relative supply of the metals created pressure for the ratio to change. The experience informed the design of monetary systems and contributed to the eventual adoption of gold monometallism and then of fiat money.

Advantages and Disadvantages

The advantages of commodity money include the constraint it places on the creation of money and the confidence it inspires. The disadvantages include the resource cost of producing and storing the commodity, the dependence of the money supply on the availability of the commodity, and the limited ability to respond to economic conditions.

The analysis of these advantages and disadvantages informs the assessment of alternative monetary arrangements and the understanding of the historical evolution of money. It also informs debates about the role of rules and discretion in monetary policy.

Contemporary Relevance

Although fiat money dominates, commodities continue to play a role in the monetary system. Gold is held as a reserve asset by central banks and by investors, and commodity-backed instruments are used in some contexts.

The analysis of commodity money informs the understanding of the functions of money and of the design of monetary systems. It also informs debates about monetary reform, including proposals for commodity standards and for the role of gold in the international monetary system.

See also

• Medium of Exchange
• Monetary economics
• Price Stabilization