Commodity Money: Definition, Examples & Characteristics

The idea is rooted in the fact that we only ever experience deflation, across the entire economy, at times when consumer spending collapses for one reason or another. The lack of spending during these periods is bad for business as it implies unsold goods, which leads to reductions in production and increased unemployment due to redundancies. That in turn leads to even less money being spent and a downward spiral of economic output reminiscent of what occurred during the Great Depression.

commodity money is are usually circulated at a face value that is greater than the costs of the underlying metal materials. There are some cases, as with runaway inflation, where coins can have greater metal value than face value. This is especially the case with coins made mostly or entirely from gold or silver.

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This category represents money that can be readily transferred into cash. The African nation of Zimbabwe provided an example of the worst-case scenario in the early 2000s. In response to serious economic problems, the country’s central bank began to print money at a staggering pace. That resulted in hyperinflation, which ran between 231 million and 489 billion percent in 2008. For instance, in addition to being commodity money, cigarettes can be smoked, while gold and silver can be used for making pieces of jewelry.

At the height of the crisis, one U.S. dollar was worth about 8.31 billion Zimbabwean dollars. In 1971, the U.S. stopped offering foreign governments gold in exchange for U.S. currency. Inflation measures the rate at which the average price levels in an economy increase over time.

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Ancient Rome was an agrarian society, and wheat was commonly used as money. Similarly, corn has been used as money throughout Europe from the time of the Ancient Greeks right up to the period of the industrial revolution. The price of all manner of tradable items would be quoted in terms of an equivalent number of oxen, meaning that cattle served as a unit of account. As indicated above, the earliest example of commodities being used as money dates right back to our hunter-gatherer days when skins & furs were used for trade purposes in order to obtain all manner of other available items. Commodity money consists of objects having value or use in themselves as well as their value in buying goods.

All three have their pros and cons, yet the arguments about commodities being safe and trusted keep them alive despite their critics colorfully referring to them as barbaric relics of ancient history. Representative is a type of money that is issued by the government and backed by commodities such as precious metals like gold or silver. The value of this type of money is directly linked to the value of the asset that is backing the money. Representative money is a type of money that is issued by the government and backed by commodities such as precious metals like gold or silver. Because it has not been recognized as legal tender by the government, as opposed to fiat money, individuals are not obligated to accept it as a form of payment under the law as a result. Instead, if the bearer demands it, the issuer of fiduciary money offers to swap it for a commodity or fiat money at the issuer’s discretion.

The variable demand for cash equates to a constantly fluctuating active money total. For example, people typically cash paychecks or withdraw from ATMs over the weekend, so there is more active cash on a Monday than on a Friday. The public demand for cash declines at certain times—following the December holiday season, for example. The M1 category includes what’s known as active money—the total value of MATIC coins and paper currency in circulation. For a booming economy, the need for gold to give money value is extremely inefficient, especially when its value is really created by people’s perceptions.

He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem. Commodity money in the time of high inflation can be used as a buffer as commodities have a value of their own, which currencies do not have. Its value is derived from its official recognition as a medium of exchange from government legislation.

History of commodity money

commodity money is money is a medium of exchange that is only backed by the government. Consider what happens when Lucy visits Bank A, and she deposits $1000 dollars in her checking account. Bank A can keep $100 aside and use the rest to lend it to another client, John. John then uses the $900 to purchase an iPhone from another customer, Betty. Furthermore, if individuals lose confidence in a country’s currency, the money will no longer have any purchasing power.

It was understood that the certificate could be redeemed for gold at any time. Also, the certificate DOGE was easier and safer to carry than the actual gold. Over time people grew to trust the paper certificates as much as the gold. Representative money led to the use of fiat money-the type used in modern economies today.

This is because, in theory, a commodity-backed monetary system means every $1 in the system must be accounted for by the same $1 equivalent of a commodity. This prevents you from creating more money than you have commodities to back it up with. Because fiat money is not linked to physical reserves, such as a national stockpile of gold or silver, it risks losing value due to inflation or even becoming worthless in the event ofhyperinflation. If people lose faith in a nation’s currency, the money will no longer hold value. That differs from currency backed by gold, for example; it has intrinsic value because of the demand for gold in jewelry and decoration as well as the manufacture of electronic devices, computers, and aerospace vehicles.

• Gold coins, corn, and cigarettes are perfect examples of commodity money since they hold intrinsic value.
• In the past, any commodity that did not comply with these standards was not accepted as commodity money.
• Today, the value of money is decided purely by its purchasing power, as dictated by inflation.
• The implication is that we would have to accept ongoing deflation and that this would suppress economic growth rates.
• The supply, and therefore the value, of 20-dollar bills—and money in general—are regulated by the Federal Reserve so that the money retains its value over time.

Currently working as a consultant within the financial services sector, Paul is the CEO and chief editor of BoyceWire. He has written publications for FEE, the Mises Institute, and many others. The ‘intrinsic value’ of commodity is a crucial part of building its trust. We can look back many centuries to when goods such as tobacco or salt were used as money. People would use them to trade with each other as they were commonly used goods.

The government-backed this currency and stated that it could be used to pay back both public and private debts. The value did, however, fluctuate according to the North’s success or failure at certain stages in the war. In the case of the U.S. dollar, for example, this meant that foreign governments were able to take their dollars and exchange them at a specified rate for gold with the U.S.

Why do we use cash and not other https://www.beaxy.com/ to perform transactions? You will know a lot more about these questions after reading our article on the types of money. Helene55 yesterday Coupons and tokens at businesses are also commodity money. For example, giving someone a gift card for a store you don’t like, but they do, can be a way of providing them with commodity money. Things like two for one coupons might also work if you know someone who really wants or needs a certain product for which you have a coupon that you don’t plan on using. Something that serves as commodity money only has to have value in itself, rather than being of use to the bearer.

Nicolaas has four years of professional work experience – having worked in hospitality, journalism, and marketing. He has a BA in Communication studies from the North-West University and has completed his TEFL qualification. He also has six years of writing experience complementing his qualified competence. Vertical integration is where two businesses at different stages of the supply chain join together.

This experience discouraged the American government from using paper money for almost a century. In the 17th century, Great Britain was determined to keep control of both the American colonies and the natural resources they controlled. To do this, the British limited the money supply and made it illegal for the colonies to mint coins of their own. Instead, the colonies were forced to trade using English bills of exchange that could only be redeemed for English goods. Colonists were paid for their goods with these same bills, effectively cutting them off from trading with other countries.

In this case, we accept the value of the money because the government says it has value and other people value it enough to accept it as payment. For example, I accept U.S. dollars as income because I’m confident I will be able to exchange the dollars for goods and services at local stores. It is not a commodity with its own great value and it does not represent gold-or any other valuable commodity-held in a vault somewhere. It is valued because it is legal tender and people have faith in its use as money. Fiat money like the US dollar seen in Figure 2 is a medium of exchange that is backed by the government and nothing else. Its value is derived from its official recognition as a medium of exchange from government decree.

Being a legal tender means that it is recognized by law to be used as a payment method. Everyone in the country where a fiat currency is recognized as a legal tender is legally obliged to accept or use it as payment. The difference between fiat money and representative money is that fiat money’s value depends on its demand and supply.