The theme of this series explores items that have become so integrated into our lives that we barely notice them; yet have completely transformed how we live. The first item in the series was the elevator—try to imagine modern high-rise cities without them. The second item was the pre-printed adhesive postage stamp—try to imagine sending and receiving letters and other things through public postal services without them. The third item was going to be about money, specifically the credit card. This  little bit of plastic  ensures we  always have access to money to buy virtually anything we want virtually anywhere in the world.

Credit cards (and slightly later debit cards) have been with us now for a little over a half-century However, some comments I received on the first draft of this proposed blog revealed something deeper, more far-reaching, and significantly older from which these life-altering cards sprang: the concept of money itself.

So to put things into their proper order, this blog will consist of two parts, first money, then the credit card and debit card (collectively called “payment cards”), and beyond.

What is Money? Really, What is It?

According to the famous song from the famous musical comedy “Cabaret”

Money makes the world go around
…the world go around
…the world go around.
Money makes the world go around
It makes the world go ’round.

Indeed it does. Virtually no one would dispute the claim, except in those rare parts of the planet that still rely on barter and where money is unknown.

Nevertheless, despite the huge transformation money has made in human society, it is generally undervalued by the billions of people who use it daily. And although it’s something we think about and use, most people don’t understand what money really is and how it works. Its influence is so pervasive that it is as much a part of us as eating and breathing.

But how can I claim most people don’t really know what money is? Because I once had an experience that dramatically demonstrated to me I didn’t really know much about money although I was certain I did. Subsequently, anyone with whom I have ever discussed the matter seemed to be laboring under the same misconception.

In the mid-1960s I was a volunteer teacher in Tanzania. I had to go on a short trip to Kampala, the capital of the neighboring country of Uganda. Both countries had their own currency but they were legally fixed against each other at par. This meant one Tanzanian shilling was invariably equal to one Ugandan shilling, and vice versa.

Two days before I left on my trip, Tanzania nationalized all the banks in the country. I crossed the border with my pockets full of Tanzanian shillings, which to all intents and purposes were the same as Ugandan shillings. However, once in Uganda, I found nobody wanted to take my Tanzanian shillings, or would do so only at a 50 percent discount. In other words, instead of one Tanzanian shilling buying one Ugandan shilling, suddenly it would buy only 50 cents.

Suddenly my excursion into Uganda was going to cost twice as much as I had budgeted. I definitely didn’t have enough cash to pay my expenses. In those days, credit cards and debit cards were largely unknown, so I didn’t have that option either. And no one was willing to accept a check. I finally had to go to the Tanzanian embassy in Kampala to borrow enough money to get me back across the border.

So what happened?

Because of the uncertainty caused by Tanzania’s nationalization of the banks, in Uganda my Tanzanian shillings had become only pieces of paper, while in Tanzania they could still buy something.

That day I learned a very important lesson that has stayed with me ever since. Money is a social convention. It is worth something only if people think it is.

Another example. Before the First World War (1914 -1918), four German marks were worth (would buy) about one American dollar. Because of the economic chaos in the country after the war ended, by 1923 it took more than 4 trillion (4,000,000,000,000) German marks to buy one American dollar. The mark had become so worthless that people were actually burning banknotes to keep warm because it was cheaper than buying firewood.

Amplifying the Dictionary

So if money isn’t really money, what is it?

A standard dictionary definition of money would look largely like this.

1. Something generally accepted as a medium of exchange, a measure of value, or a means of payment.
2. The official currency, generally as monetary tokens in the form of paper and metal coins issued by a national government.

These are rather dry, dispassionate descriptions of money (as dictionary definitions are wont to be) that barely scratch the surface of how the invention of money totally transformed society. And, more importantly, how people live and interact with one another.

In more evocative terms, the first definition might better say: Money is a token that has a universally agreed value and is expected to retain that value over time. The basic purpose of money is to facilitate commercial transactions, i.e. buying and selling things (or as economists like to say, “exchanges of goods and services”).

The second definition might better say: Money is a country’s official currency, i.e. the government says which monetary tokens will be considered to be money and which will not. But it doesn’t stop there. The government must also ensure tokens that look like money actually are (i.e. not counterfeit). In short, the value of money depends on trust. If you trust, it has value. If you don’t trust it, it doesn’t.

This is why you can’t spend Norwegian kroners in Spain, you can’t spend Mexican pesos in China, you can’t spend Brazilian reals in South Africa, you can’t spend British pounds in the United States, etc. The government of each country decides what it will accept as being money and what it will not accept, because this is how it must be.

Put more dramatically, you could have a million U.S. dollars in New York and be a pauper in Tokyo. People in Tokyo would certainly recognize your U.S. dollars, but they still wouldn’t accept your money because it is not considered legal tender in Japan. This is why you would first have to go to a bank and use your dollars to buy Japanese yens.

And yes, if you have never thought about it before, money can be bought and sold just like anything else. Although we talk about “converting” money, what we are actually doing is buying one country’s money and selling our own.

Like anything else that is bought and sold, the price of money varies. This is known as the “currency exchange rate” (currency is another word for money). For example, suppose you go to the bank to convert U.S. dollars into Israeli shekels. For $100 the bank gives you ILS 360. A week later you decide you need to convert more money. This time for $100, the bank gives you ILS 368. In other words, the “price” of the Israeli shekel has gone down, so you get more shekels for your dollars than you did a week earlier.

In a commercial transaction, the exchange of goods and services could be completed with something as simple as an oral agreement or a written promissory note (I.O.U.). However, this would not count as money. Why? Because of its limited interchangeability—it is not universal. I give you something or do something for you, you give me an I.O.U. promising that you will later give me something or do something for me of equal value. But that’s as far as it goes. If I need something you don’t have, I can’t easily go to someone else with your I.O.U. to get what I want. They are likely to say, “Sorry, I don’t know who you are or the person who wrote this I.O.U. I see no reason to give you what you want for a piece of paper written by a stranger.”

Even though I have your I.O.U., if I come back for something I want but you don’t have I’m stuck. I must wait until you do have something I want while still trying to figure out how to get what I want now from someone else.

Thus, even with a valid I.O.U., we still have a kind of barter system. I give you something and you give me something in exchange. It’s a one-to-one relationship. This works in a small, simple community where everyone knows everyone else. However in a large, complex community where most people don’t know each other, it would bring chaos.

So how to resolve the problem? The answer is as obvious as it is difficult to implement.

Suppose there was something that everyone wanted and could easily be exchanged for goods and services with anyone else? It would then no longer be necessary to write a personal I.O.U., which others may or may not accept. It would only be necessary to offer someone an agreed quantity of the magical thing everyone wants and the deal would be done.

If this idea makes you think of gold or silver, it should. Traditionally, gold and silver have been two things virtually everyone wants. With gold or silver, it is not necessary to find someone who wants it in order to buy a pair of shoes or get your house painted. You only have to find someone who sells shoes or paints houses, agree on a price (how much gold or silver), and that’s that.

Brilliant, right!

Indeed, it is. Now we can better understand what is meant by a medium of exchange (token). It is something virtually everyone wants and with which you can buy virtually anything you want—even from total strangers.

However, we are still not yet at the end of our pains. If I come to you with what I claim to be 40 grams of gold to exchange for a pair of shoes, how can you be certain that what you are getting is really 40 grams of gold? It may be 30 grams of gold mixed with 10 grams of iron pyrites (fool’s gold), which looks like gold but doesn’t have the same value. So we still have the same problem. I don’t know you, so how can I trust that what you claim to be 40 grams of gold really is?

A theme seems to be emerging. For anything to be a true medium of exchange, i.e. money, the people who use it to buy and sell things must trust that it is really worth what someone else claims it is worth.

The Invention of Official Money

As far back as 650 B.C.E., the government of Iona (now western Turkey) began minting coins made of electrum, a naturally occurring alloy of gold and silver. The fact that these coins were minted by the government and there were severe penalties for anyone producing counterfeit (fake) coins, provided the trust people needed. With this official money, they could go anywhere and do business with anyone in full confidence.

Problem solved.

Today gold and silver coins are no longer used as money,  rather coins with lesser or essentially no intrinsic value as well as paper money are the norm. More than ever before, the value of money depends on the government saying it is money, and the confidence people have in the government that says so. This is why countries such as China, Japan, the United Kingdom, and the United States can have their own currencies. People consider these governments to be stable and the economies of these countries, despite normal ups and downs, to be dynamic and productive.

Many countries don’t enjoy such a good reputation or have other problems in gaining the people’s trust. To get around the difficulty, together with issuing their own currency—and sometimes instead of issuing their own currency—such countries share currencies. For example, Panama uses the U.S. dollar alongside the Panamanian balboa as official currencies. Other countries that use the U.S. dollar as one of their official currencies include Ecuador, El Salvador, East Timor, the Federated States of Micronesia, the Marshall Islands, and Zimbabwe.

The euro, created in 1999, is now the official currency of 19 of the 28 members of the European Union, replacing the German mark, Greek drachma, French franc, Italian lira, Portuguese escudo, Spanish peseta, etc. Not all the countries of the E.U. have replaced their national currencies with the euro for the following reasons:

• Adopting the euro is not required for E.U. membership. Several countries, notably Denmark (D-krona), Sweden (S-krona), and the United Kingdom (pound sterling) chose to keep their own national currencies.
• Countries in the E.U. must meet certain standards before they can adopt the euro. Several of the E.U. countries still outside the eurozone, notably in Eastern Europe, would like to replace their national currencies with the euro but have not yet met the criteria that would allow them to do so.
• Certain countries are hesitant about adopting the euro for fear that abandoning their own national currency would compromise their national sovereignty. To a certain degree, they are correct. Historically, independent countries have in part defined their independence by having their own currency. In certain countries, it is strongly believed whatever political and/or economic advantages might accrue from adopting the euro would not be worth the loss of some of their national sovereignty. The United Kingdom generally heads this list.

Vestiges of Bartering

Some people are fond of saying the barter system is somehow “primitive” and it has no place in modern economies run on official money. However, this is not entirely correct. Even with official money, we still have the problem of setting prices.

I may wish to offer you 40 grams of gold in official gold coins for a pair of shoes, but you may think the shoes are actually worth more, say 50 grams of gold. So we still must agree on the price. This modern form of limited bartering is often referred to as “haggling.” And it still goes on everywhere in the world despite the existence of official money.

The notion of haggling may make you think of souks or other forms of direct-to-customer markets. However if you are employed, how was your salary determined? This was probably the result of haggling, either directly by you, your union, or some other social intermediary. Your employer wishes to pay you as little as possible, while you wish to be paid as much as possible. Coming to a final agreement in terms of money, working conditions, vacation time, health benefits, etc. all come about through haggling, disguised under the rather more urbane name of “negotiations.”

Okay, so haggling represents a kind of bartering, but it is still based on the concept of official money. So today bartering is just a detail, not a determinant. This is true in most parts of the modern world; however, there are still parts of the modern world where this isn’t true.

Let me once again draw on my time in Tanzania. I was stationed at an educational complex about 16 kilometers outside of a small town. Each Saturday a group of us would drive into town to do our weekly shopping. The first couple of times I did this, I noticed people walking along the roadside carrying piles of sticks and branches on their heads starting from about 10 km outside the town. I was curious, so I asked the person driving the car what they were doing.

“Oh, they’re going into town to sell the wood at the open-air market.”

“And how much do they get for such a load of wood?”

“Oh, about a dollar.”

I was shocked. Seeing people walking up to 10 km carrying loads weighing up to 10 kilograms in order to earn a single dollar was beyond my comprehension. “And what do they do with that dollar,” I asked. “Usually they go to the nearest supermarket, buy a Coke, drink it, then walk back to their home village.”

Now I was really shocked, so he explained.

“These people live in tiny mud-hut villages. They do essentially everything for themselves or acquire what they need through barter; money plays no role. They don’t go into town to sell loads of wood because they need to, but because they want to. For them, earning a bit of money and then buying something with it constitutes a great day out. When they get back to their villages, they forget all about money and just resume their normal lives.”

It took me a few moments to get my head around the idea, but it was true. This is a major advantage of visiting, and preferably living, somewhere completely different from where you were raised. It allows you to see and experience things you might find difficult, if not impossible even to imagine.

The Myth of Intrinsic Value

The term “intrinsic value” refers to something that is valuable in and of itself. Historically,  prime examples of things with intrinsic value have been gold and silver. Although the term intrinsic value is widely used, it is important to bear in mind essentially nothing has intrinsic value.

The value of gold and silver can go up and down widely on international precious metal exchanges. For example, in 2006 the price of gold on the international market stood at just over $400 an ounce. By 2011 it had risen to more than $1,800 an ounce, a four-fold increase. At the end of 2018 it stood at $1,300 an ounce.

Gold and silver have gained the reputation of having intrinsic value because they are prized for making jewelry and have other less ostentatious uses. However, if the fashion ever changes or cheap substitutes could be found for gold and silver, their so-called intrinsic value would sharply decline—perhaps even dropping to zero.

In short: Something is worth only what someone else is willing to pay for it.

Intellectually, this is an easy concept to understand; however, with regard to money, viscerally it is extremely difficult to accept.

Remember, money like everything else can be bought and sold. However, it is hard to shake the belief that money minted in gold and silver somehow has intrinsic value while money as printed pieces of paper doesn’t.

This history of paper money is long and complex, going back at least 2,000 years. The purpose of paper money was to oil the wheels of commerce by permitting wholesale merchants to buy and sell things without being burdened by heavy sacks of metal coins. Nevertheless, throughout most of its history, paper money was closely tied to the concept of the assumed intrinsic value of gold and silver. These pieces of paper guaranteed the bearer could go to designated locations (usually banks) and exchange them for gold, silver, or other precious metals.

In short, paper money was a kind of promissory note (I.O.U), because it promised the bearer could redeem the printed value of the paper at any time.

It is only within the past century that most governments around the world have broken this link between paper and “real money.” Today, a U.S. dollar is a U.S. dollar, period. Until 1971 it was still a promissory note allowing the bearer to exchange it for gold or silver coins. Today, no such exchange is possible. Likewise this is the case for virtually every other paper money virtually everywhere on the planet.

But there is serious risk in detaching paper money from some kind of precious metal backing—hyperinflation.

I experienced this momentarily when I crossed the border into Uganda. From one day to the next, my pocketful of  Tanzania shillings lost 50 percent of their value. Post WWI Germany saw it marks lose virtually 100 percent of their value.

In more modern times, we have seen the same thing happen in Nicaragua, Peru, Yugoslav, Zimbabwe, and of course Venezuela.

If detaching paper money from gold and silver can lead to such horrendous catastrophes, why do governments do it? Economists will adduce numerous technical reasons, but perhaps the fundamental reason is today’s complex, integrated world economy simply couldn’t function if paper money still had to be backed by precious metals.

This is why central banks and other national and international organs of monetary control are so important. These “gray men and women” are constantly working to keep detached paper money (“fiat money”) under control. Often this means standing at odds against influential politicians. When their moderating actions are overturned by political power, disaster can ensue. And the suffering can be unimaginable.

If all money is now fiat money, why do modern nations still have gold reserves?

Some of them don’t. In the 1960s Canada, one of the world’s leading economies, had more than 1,000 tons of gold in its reserves. Since then it has sold off almost all of it, today now having less than one ton of gold left.

By contrast, the United States has immense reserves of gold. They are immense in relation to the reserves of other countries, but puny in relation to the number of paper dollars in circulation. Specifically, until 1971 every dollar in circulation could be redeemed for an equivalent amount of gold. Today this is no longer legally possible. Neither is it physically possible.  There are many times more dollars in circulation than gold in Fort Knox, Kentucky, where most of the U.S. gold reserve is stored.

If paper money has been completely detached from gold, then why hold any gold reserves at all?

There seem to be two reasons.

First is nostalgia. Even people who fully know and understand paper money and gold no longer have anything to do with each other fondly look back to a time when they did. So simply having a certain amount of gold in government reserves just makes them feel better.

Second, in extreme circumstances that gold might come in handy. Confidence in a national currency depends on economic factors,  such as the country’s trade balance (business with other countries), its national budget (in surplus or in deficit), etc. If people begin to lose confidence in a national currency, its exchange rate will decline. In other words, it will take less of the currency of one country, say the U.S. dollar, to buy the currency of another country, say the Venezuelan bolivar. If the situation becomes critical, commercial relations between individuals and companies doing business in the country with the rapidly depreciating currency may come to a virtual standstill. Trade may still continue at a government-to-government level, probably using gold or a hard (stable) currency as the medium of exchange, but certainly not the essentially worthless currency of the country with the failing economy.

Beyond Cash

We have covered a lot of ground in this review. Before moving on, here is a summary of the key points.

1. Money is a universal token having a value that is expected (but not guaranteed) to be stable over time and trusted by the people. This universal trust is usually established by fiat from a national government issuing and “standing behind” its currency.
2. Money is a great facilitator of exchange transactions, the core of commerce.
3. To increase trust in paper money, governments originally offered to exchange a specified amount of gold for a paper bill. Now that governments have broken the link to gold, citizens’ trust in money must come solely from trust in their government.
4. Barter is not gone. It is alive and well. Haggling over a price or negotiating a salary are forms of barter.
5. Money has no intrinsic value. Even when money is equated with silver or gold, the value of money can fluctuate with the prices of these metals.
6. Money must quickly and seamlessly move from one place to another in today’s largely integrated worldwide society, which was not the case in local, largely isolated agricultural societies.

In part 2 we will  look at the short history (­give or take 60 years) of the credit card.  In particular, the credit card’s amazingly rapid and fundamental influence on today’s high-speed industrialized society; how computing helped to make the transformation happen; and what may happen next.