Commodity Money

For most of recorded history, money took the form of physical commodities -- primarily precious metals -- that were presumed to carry intrinsic value independent of any institutional guarantee. Gold and silver could not be conjured by a decree or printed on a press; their supply was constrained by geology, mining technology, and the accidents of conquest. This apparent independence from human manipulation gave commodity money a reputation for reliability that later monetary forms have struggled to match.

The reality was more complicated. Gold and silver carried value not primarily because of their physical properties -- their chemical stability, their scarcity -- but because of social conventions enforced by states. Rulers who accepted only gold or silver in payment of taxes created demand for those metals throughout their jurisdictions. Merchants who refused other forms of payment reinforced the convention. The intrinsic value of precious metals was, from the start, partly a construction of institutional authority.

This became apparent whenever commodity money failed. Clipping -- shaving metal from the edges of coins -- debased the currency while maintaining its nominal value. Rulers who needed revenue beyond what taxation provided would reduce the metal content of coins while demanding that subjects accept them at face value. The periodic debasements of the Roman denarius, the medieval penny, and dozens of other coins illustrate that commodity money was never as independent of state manipulation as its champions claimed (Spufford, 1988).

The gold standard did not discipline governments -- it disciplined workers. Its stability was purchased at the price of persistent unemployment and deflation in the name of convertibility.Barry Eichengreen, Globalizing Capital (1996)

Despite its impurities, commodity money had one genuine advantage: it imposed a form of external discipline on monetary expansion. A government that could only spend metal it possessed could not simply create money at will. This constraint protected creditors and savers from inflation -- and imposed corresponding costs on debtors and on economies that needed money supply to grow with productive capacity.

The gold standard of the late nineteenth and early twentieth centuries represented the most systematized form of commodity money discipline. Under it, central banks were obligated to exchange their currency for gold at fixed rates, limiting their ability to expand the money supply in response to economic conditions. This rigidity proved catastrophic during the Great Depression, when governments bound to the gold standard were unable to expand money supply to counteract collapsing demand. The experience remains the most powerful historical argument against commodity money as an organizing principle for a modern economy.