March 5, 2021

The nature of money

Money is perhaps the most talked about phenomenon in the economic literature. In the past a question about their origin and nature actively discusseda wide range of economists and political scientists. The origin of the prevailing view on the nature of money can be traced from the depths of history, starting with the works of such ancient thinkers as Plato and Aristotle, whose positions are well expressed in the following quotations:

"Plato calls money" a sign for exchange. " And Aristotle, in the often cited passage, says that "money came about by common agreement, not by nature, but by establishment." Even more clearly, he expresses this point of view in his “Politics”, where he says that people “... came to an agreement to give and receive through mutual exchange something that would be of value in itself ... for example, iron, silver or something else ... ", And offers this as his explanation of the origin of money." [1]

And to this day, these samerepresentations that money arose as a result of a certain social contract or legislative acts. This point of view is so deeply rooted that at the moment it is very common to say that money is just a “mass illusion” perceived by all members of society in the name of the common good. The logical conclusions from the above assumption led to the wrong judgment that everything that people collectively agree on can be money, and that the public is not only capable, but must actively control existing money and its production.

The first refutation of this view wasoriginally represented by Scottish economist John Law, who attributed the origin of money not to a social contract, but to the characteristics of specific goods that performed the role of money, especially metal money [2]. One of the most prominent thinkers of the opposite theory was Carl Menger, founder of the Austrian School of Economics. In his work, The Foundations of Political Economy, he outlined probably the most accurate to this day concept of the origin of money [3].

This article addresses the issue of from an economic point of view, their origin is explained and the misconception about "mass illusion" is debunked. We will discuss the economic reasons for the spontaneous appearance of money, as a result of individual rational behavior, as well as the quality of the goods, most noticeably affecting the likelihood that it will become money on the market. We will start with the fundamental economic concepts necessary for a complete understanding of money, and gradually, relying on them, we will come to a comprehensive explanation of the nature of money.

Economics and economic activity

The problem of understanding the nature of money is economic in nature. Therefore, we must first understand what economic science is and, based on this, develop an appropriate approach to this issue.

Economics is the study of laws governingactivities of economic entities. It considers the phenomena that arise as a result of such activities, and gives us the basis for their understanding. Economic science proceeds from the fact that each individual's desire for thrift, through economical activity, is a deliberate attempt to ensure the most complete satisfaction of his subjective needs.

We define here the economic effect, orsaving action, as a targeted action performed by a saving individual with the intention of improving his well-being, allowing him, directly or indirectly, to more fully satisfy his personal needs.

Therefore, approaching such an economic phenomenon,like money, we should try to investigate what economic actions led to their appearance in every human civilization throughout history.

The phenomenon of money is inextricably linked with the generaleconomic activity of exchange and stems from it. The usefulness of money can be explained mainly, if not exclusively, by their use in exchange. Undoubtedly, money will never be present in the economy without exchange (for example, in the economy of an individual economy), and therefore it would be most appropriate to begin our study with the study of exchange as an economic phenomenon.

Exchange as an economic action

Early economists initially misinterpretedexchange issue, because they did not consider it as an economic activity. When Adam Smith wrote that the cause of the exchange may be “people's tendency to exchange, trade and exchange” [4], he refrained from considering this problem from an economic point of view and did not consider exchange as a purely economic action.

Later economists found that the mainthe reason for the exchange was the recognition by economic entities of the possibility of improving their well-being. The exchange allows them, under certain conditions, to take possession of goods that have a higher value for them, at the expense of goods with a lower value, exchanging with another individual who has the opposite opinion about the value of these two goods personally for him. Understanding this process was crucial for the further development of economic science, since any economic theory dealing with exchange should be based on this understanding.

It should be noted that exchange is the mostrational economic action that people can perform when they learn about the existence of a certain connection between their needs and the goods that they own. If the exchange is not economically beneficial for both parties to the transaction, then there is no doubt that the exchange will not take place (in the absence of coercion). As a result of this, it becomes clear that exchange is a purely economic behavior that does not occur on a predisposition, but only on condition that it improves the well-being of those participating in it.

Goods and Trade

A fundamental understanding of money cannot be complete without a discussion of its origin. To do this, we need to start by studying the concept of goods in the economy.

The economic definition of “product” that II use it here is one that was traditionally used by the old German economists of the 19th century [5]. This definition, perhaps, is not suitable for frequent use in everyday speech, but it is an appropriate formulation when working with economic literature. We define a product as an economic good owned by an individual with the intention not to use it, but to exchange it in the course of trade. For example, shoes made by a shoemaker, as a rule, are not intended for use by himself, but are made for exchange for something more useful. Therefore, shoes are a commodity for a shoemaker. When a person has something that he considers a product, it means that he assigns a higher value to another product for which he can exchange his product than the potential satisfaction from the consumption or use of his own product. That is, he perceives his goods as having a higher “exchange value” than his “use value”. Therefore, shoes are considered to be goods when they are with a shoemaker intending to sell them, but not after he exchanges shoes with a buyer who plans to wear them.

The more progressive the division of labor and thethe more developed the economy, the more there will be cases when manufacturers produce goods solely because of their exchange value, practically taking into account their use value. Moreover, we can even observe the development of trade not only between producers of goods and consumers, but also trade of manufacturers with a different type of traders. This other type is sellers who want to purchase goods not for consumption, but for the expected profit in the subsequent exchange. So, in fact, many subjects of the modern economy work, such as retailers who buy goods for the sole purpose of exchanging them with consumers (for example, grocery stores), and speculators who try to predict future prices for goods and trade for them, respectively.

The general phenomenon of economic entities,producing and exchanging for goods that have no use value for them, obviously, is the result of economic actions of people striving to better provide for themselves. In carrying out these actions, people expect a certain demand for these goods at a specific time in the future and base their prudent activity on these subjective assumptions. This expectation leads to the general phenomenon of exchange and trade, which we observe in everyday life.

Product sales

Selling concept related to sizeeconomic losses required for the sale of goods. Obviously, various goods, due to their many qualities and sources of demand, usually require a different degree of economic cost for exchange. Economic costs of the sale may occur in the form of a discount on the price of the goods, but most often it will be the cost of the delay in the sale, that is, the time during which the seller is forced to wait until the exchange occurs.

For example, let's look at the difficulties withwhich the eyeglass manufacturer will encounter when looking for an exchange opportunity, having come to the market with glasses made for a certain degree of myopia Even though there is likely to be a potential buyer for the glasses, who is ready to purchase them at a cost-effective price, the search for this buyer will take some time. In addition, even if there is a buyer, it is likely that he will not have a product that has consumer value for the seller of points. If we now assume that, for some reason, the seller of points needs an urgent exchange, then he is unlikely to find someone who agrees to purchase them at a price that suits the interested buyer, that is, at a "cost-effective price." If, instead of the seller of glasses, we take an example of a baker who brings bread with him to the market, it will become clear that he will be in a much better position to look for an opportunity to exchange for the goods he needs at a bargain price.

The reason for this difference in this case could bewould explain that the market for glasses is much smaller, since only a few people need them. Other reasons for the different market attractiveness of the goods may be differences in the offer, the cost of production of new units, the divisibility of a certain amount of goods into smaller parts, transportation costs, etc.

Origin of money

When economic actors realize increasedexchange opportunities that open before them when offering goods with high market attractiveness, they will be forced to exchange their goods not only for goods having a useful value for them, but also for goods that will reduce the economic costs associated with the exchange, i.e. on goods that are more selling. The more people are aware of the differences in the market attractiveness of the goods, the more suitable exchange opportunities will be. An exchange for goods in high demand will ultimately allow them to achieve their ultimate goal - to obtain goods that are useful to them, but with lower economic costs and difficulties than without an intermediate exchange.

Let's get back to the above example, andNow suppose that the seller of the glasses finds out about the greater market attractiveness, the relatively lower economic costs of finding the possibility of exchanging bread in comparison with the glasses he offers. Realizing this, he will certainly be ready to exchange his points for bread if he has the opportunity to do it at a reasonable price, even if the bread has no useful value for him. The reason is that he understands that the chance to find an opportunity to exchange (at economically advantageous prices) for goods that have useful value for him will be much better if he goes to the market with bread and not with glasses. By exchanging points for bread, the seller of points can reduce the economic costs of the entire exchange process, allowing him to get the desired goods with less economic loss of time or cost.

Thus, it becomes clear that readinessan individual to accept a product with a higher market attractiveness compared to the goods currently available to him is the most rational approach in the absence of the possibility of a profitable direct exchange for the goods that he really wants. In the economy, this behavior will lead to an increase in demand for more sold goods, not because of their use value, but solely because of their exchange value.

The process of increasing demand for better-sellinggoods will further enhance their feasibility, as more and more people choose to exchange for them. One can observe how this process intensifies, as a result of which more sold goods become even more sold, and less - even less.

Therefore it is not surprising that as a result of thisonly a few of the process, or even a single product, will remain in demand because of its market attractiveness. A product that remains in great demand at the very end, we call "money." The process itself we can call "monetization", or the conversion of goods into money.

Consequently, the origin of money goes backrooted in the special qualities of the product, due to which it became more sold, which caused even greater demand for it, and led to the fact that it became a common medium of exchange, which was called money.

The described theory is compatible with all knownvarieties of money in the past. Cattle, sea shells, glass beads, furs, copper, silver and gold are some of the most notable examples of commodity money that have come to us from the depths of centuries. You can see how their characteristics, such as use value, divisibility, interchangeability, portability and durability, may have led to the fact that they were initially more salable than other products. Thus, they were in high demand and became money, according to the economic situation in certain economies in specific periods of history.

As another factor influencing their appearance inquality of money, we can distinguish the general economic situation and the type of society in which they were used. For example, cattle was ordinary money at the nomadic stages of the development of society, since it was durable, easily transportable, and people had enough space to “store” it. However, with the development of civilization to more permanent settlements, and then cities, the suitability of cattle as a means of exchange has decreased significantly. At the same time, sales of precious metals began to grow rapidly, until they eventually became the new monetary standard.

Fiat money market attractiveness

There is a special kind of money, which at firstthe view seems incompatible with the above theory, namely, fiat money. However, here I am willing to argue that the same theory can be applied to explain their occurrence, if we take into account state legislation as a certain factor of influence on the economic situation.

Fiat (maternity) money is, as follows fromnames, money that are declared as such by the state. Historically, governments usually stopped other money and converted it into paper money, for example, by suspending the redemption of gold certificates. There are two measures of influence that governments use to promote and preserve fiat money as a means of payment: 1) the rules that impose restrictions and barriers on the possibility of selling other goods [6]; and 2) laws on a means of payment, requiring citizens of the state to accept its fiat money at a cost determined by the state and establishing fiat money as the only ones allowed to pay taxes.

The reason for these two types of interventions can be easilyunderstand if you apply the theory of money. In the first case, the government, using its monopoly on violence, artificially reduces the marketability of goods that would otherwise be more attractive to the market than fiat money, and therefore would be more likely to spread as a medium of exchange. In the second case, it creates an artificial demand for its fiat money, requiring its use as a means of tax payments, and forcing people to accept them at a “face value”, usually much higher than their value in the market. This increased “artificial” demand for state fiat money, accompanied by an artificial decrease in the feasibility of other goods, leads to the fact that paper money becomes the best-selling product, thus turning into a medium of exchange, i.e. money.

Feature of fiat money in comparison with otherstypes of money consists in the fact that fiat money acquires its market attractiveness not because of the free actions of economic entities, but under duress and because of the threat of violence through legislation. We must, however, declare that this manipulation is still consistent with the theory of the emergence of money, when the best-selling product becomes money, without the need for a collective agreement on the subject of money. There is a long history of fiat money losing its purchasing power even when regulatory legislation is still in place (for example, in hyperinflation scenarios). These cases should reinforce the argument presented here, since it shows that even if the “political agreement” (legislation) is still in effect, legal money may lose its solvency due to changes in their characteristics (in case of hyperinflation, the amount of money in circulation) . When this happens, we see how another product that is not legal tender appears in circulation and replaces fiat money, which is being squeezed out of circulation, as a means of exchange. Thus, we can see that money is not prescribed by law, but arises from individual economic actions of people.

Both historically and theoreticallyThere are good arguments against the introduction of paper money. However, here we are dealing with their appearance and the reason for their use in the economy, and we should consider government intervention as a specific economic situation, trying to understand its significance for the appearance of money. Thus, we conclude that fiat money is indeed compatible with the Mengerian theory of the origin of money.

The nature of money

Now let's move on to the question we started with, thenthere is to the nature of money. From the foregoing, it should be concluded that the phenomenon of money is a logical, spontaneous result of the economic efforts of individuals. It does not follow from a collective decision, but from the prudent activity of economic entities acting in their best interests. Throughout history, we have witnessed various cases of the appearance of money not only without legislation, but sometimes even despite and sometimes contrary to existing legislation, and without any explicit coordination between market participants. Therefore, money is not a social or political, but an economic phenomenon.

The misconception that money is "massan illusion, ”at best, is a superficial observation and does not give us any economic explanation of the phenomenon of money. The reason why many consider this erroneous opinion convincing is most likely a confusion of use value and exchange value, as well as a misunderstanding of the theory of goods as a whole.

The explanation usually given to justifyThis statement is that people value money not for their use in the sphere of consumption, but because they expect that in the future they will be able to exchange them for other, useful goods. Obviously, in many cases, the use value of money as such does not exist for the mass of people, but they are willing to exchange it. Based on this observation, they conclude that the acceptance of money in exchange should be contrary to the best personal interests of the person and, therefore, that this can only come from a collective agreement.

At first glance, this argument seemsconvincing, but after our study of the origin of money, you can easily discard it, since we have proved that accepting money for the goods really meets the best personal interests of economic entities. It is clear that one who will be among the first to realize the economic benefits of exchanging their goods for more sold ones will have better and more numerous opportunities for exchange at lower economic costs. As a result, they will be able to satisfy their needs better than others. Over time, as the market attractiveness of certain products grows, and as knowledge spreads, more and more people will imitate this behavior, as its positive effects will become more noticeable. Thus, the use of certain goods as a medium of exchange will prevail until money appears on the market.

Along with this process, while alonegoods become more sold, others, respectively, become less sold, economically punishing those who do not exchange for money, because they will have fewer opportunities for exchange, and they will become more economically isolated. Here we see that the use of money in the economy is an economic activity in the best personal interests of each person, which refutes the need for a "social contract" or "common illusion" for the emergence of money.

From all this, we also understand that the choicethe substance of money is not at all arbitrary. Rather, it is a predictable result of the influence of the characteristics of a particular product in combination with the influence of the current economic situation in the process of monetization of this substance.

Perhaps one could stop here atour presentation of the shortcomings of the theory of money "social contract". However, I think we can learn even more about money and the economy by digging a little deeper.

It should be noted that this theory is not able torecognize that the same relationship that she describes exists not only with money, but by definition with all goods. For example, a farmer can produce grain in large quantities, significantly exceeding his personal needs, so any unit of grain has practically no useful value for him. However, no one will argue, arguing that it is irrational for the farmer to produce in such volumes, hoping for an exchange in the future. This is the same relationship that we observe with money and all other goods.

A specific feature of money is thatthe demand for them is mainly due to their use as a medium of exchange, which helps to reduce the demand for their use value. However, this observation does not apply to the general relations that we are discussing here, since the fact of production and exchange of goods, only because of their exchange value, is obvious regardless of the source of demand for them.

The second significant flaw in terms of money,as a "mass illusion", lies in the fact that such an explanation is not of an economic nature, and only therefore it can also be rejected as too superficial. The very essence of economic science is to discover the laws governing economic entities, that is, to understand the phenomena that we observe in economic life that are the result of targeted economic actions of individuals.

Economics takes fundamentalpraxeological a priori reasoning, suggesting that people behave purposefully. Therefore, any explanations that regard economic actions as inexplicable inclinations, illusions, herd instinct, or any other justification for avoiding evidence should be rejected as contradicting economic theory.


The nature of money stems from the economicthe activity of individuals acting in order to most fully satisfy their needs. Money is a product that is in demand because of its relatively higher sellability relative to other products, and which therefore circulates in the economy as a medium of exchange. The appearance of money occurs spontaneously and is the result of the activities of economic entities trying to exchange their goods for other goods, which will require lower economic costs to find the possibility of exchange. In the entire history of money, there has not been a single case where people would come together to make a collective decision to establish some kind of arbitrary object as money. The concept of a “social contract” is completely alien to the origin of money, which begins with the economic actions of individuals and is distributed through the market. A specific monetary substance is not random and arises from the internal properties of the product and its subsequent suitability for sale in this particular economic situation.


[1]: Plato "The State", Book II, Art. 371B; Aristotle "Nicomachean Ethics", book 5, 1133a, 29-32; Aristotle "Politics", Book I, Art. 14, 1257a, 36-40.

[2]: John Law, “Money and Trade Considered in Connection with the Proposal to Provide the Nation with Money.”

[3]: Karl Menger, The Foundations of Political Economy, Chapter VIII, The Doctrine of Money; see also his later work, The Origin of Money.

[4]: Adam Smith, A Study on the Nature and Causes of the Wealth of Nations.

[5]: Karl Menger, “Foundations of Political Economy,” Chapter VII, “... many, especially from German economists, understand goods intended for the exchange of (economic) goods of every kind. ”

[6]: Probably the most relevant contemporary example is Decree 6102, issued on April 5, 1933 by President Franklin D. Roosevelt. He almost completely forbade possession of gold in the United States until it was abolished in 1974, 3 years after the introduction of completely irrevocable fiat paper money.