The Form of Money: Rice, Cheese, Stones, Gold, and Paper

Money is truly an amazing invention that lubricates economic exchange. As Milton Friedman writes, money in its current paper form is almost magical. With money, one is able to obtain real goods-food, drink, transportation, and housing-in return for flimsy pieces of paper. Furthermore, the ability to store wealth means that retirees can live for decades off their savings.

I am reminded of the power of money when I travel to exotic locations. Emerging from a busy and frequently dusty airport, I am immediately able to get help from strangers simply by offering a piece of paper. These strangers are willing to help me because other people will, in turn, grant them valuable goods and services in exchange for the paper that I provide. Both transactions are made possible by the fantastic tool of money.

For all of its wonderful positive effects, money immediately creates the potential for trouble that is not possible with barter. Recall that because of simultaneous medical operations, our kidney-swapping couples are sure that the other couples will do their part. In contrast, in any transaction using money, one side gives up something of immediate value in return for the promise of future value. Those who trade a hamburger today for a dollar they will spend next Tuesday (or 10 years from next Tuesday) risk the prospect that the dollar will lose some of its value before it is spent.

Part of the risk of money lies in its somewhat ephemeral nature. Modern paper money has value only because others perceive it to have value. As Professor Friedman writes, Why should they [dollars] also be accepted by private persons in private transactions for goods and services? The short answer-yet the right answer-is that each accepts them because he is confident others will. The pieces of paper have value because everybody thinks they have value. 3

Unlike dollar bills, some earlier forms of money had intrinsic value.

Rice and other grains were used in a variety of cultures.4 The recipient of rice money knows that even if everyone else stops accepting payment in rice, he or she can eat the money. For similar reasons, some northern European cultures used cheese as currency.5

While rice and cheese solve the problem of future repayment, they have their own problems. They can be bulky, hard to store, and subject to decay. Imagine the difficulty of keeping your retirement account entirely in the form of rice, or hauling a giant sack of cheese to the car dealer. Other forms of money can improve upon these commodity currencies.

Throughout the ages people have been willing to die and kill for gold. On the surface, this might seem ridiculous, as gold has very few actual uses (and cannot be eaten!). Gold has value not for what it can do, but because it solves many of the problems with commodity-based currencies like rice and cheese.

If we were to imagine ideal money, what characteristics would we seek? Ideal money would be easy to verify, impossible to counterfeit, portable, and not subject to decay. Gold has been an important currency throughout human monetary history because it has many of these characteristics. It is scarce enough that small amounts have value, thus making it portable. It is relatively easy to detect fake gold, and gold does not rot when stored. This seemingly simple set of features explains why gold can launch (and sink) armadas, ruin friendships, and dominate dreams.

For all of its advantages, gold and other naturally occurring forms of money still have problems. Residents on the Pacific Island of Yap discovered this through an interesting experience.6 This is an old story that has become famous because it is included in Professor Gregory Mankiws best-selling textbook (called simply Macroeconomics).1 (Professor Mankiw taught in the Harvard economics department and is currently the head of President Bushs Council of Economic Advisors.)

The residents of Yap use money called fei that consists of large stone wheels shaped liked coins that can reach up to 12 feet in diameter. These fei have many of the optimal characteristics of money. They are difficult to counterfeit and they do not decay. While the fei are not portable, they

are stored in the equivalent of banks and do not get moved very frequently. The fei can change ownership without being physically moved. Because the society is sufficiently small, everyone knows who owns which fei, and consequently there is no risk of theft.

Many years ago one of the fei was washed away during a storm. The people of Yap faced a choice. Should the person who owned the money be liable? If so, that person would suffer, but so would the whole society. As Professor Friedman has shown, the amount of money affects economic activity. Thus a decrease in the amount of money would likely harm the overall economy. The residents of Yap decided that the lost fei should still be credited to its owner. So while the actual fei remained lost, all the residents simply acted as if it were still on the island. They kept track of who owned the fei and-many years later-this virtual fei still existed in everyones mind and was used in transactions.

The story of stone money on the island of Yap illustrates the problem with any tangible currency. If such currency is used, then the ability to create money is taken out of the governments hands. So in the case of Yap, the entire society would have had less money if the washed-away fei had been declared lost. In the case of gold, the quantity of metal is determined not by government, but rather by the foibles of discovery and mining technology.

As well see, government control of money is frequently the source of monetary misery. Nevertheless, few leaders want their economy to be subject to the ebb and flow of gold production. The United States was effectively on a gold standard from the Bretton Woods agreement in 1944 up until 1971. Because President Nixon wanted to stimulate the economy, something that was difficult to do under the rules of Bretton Woods, he removed the fixed link between U.S. dollars and gold. Today, every major country has made a similar move, and money has been decoupled from anything tangible. We live in an era of so-called fiat money where the supply of currency is dictated by government command (or fiat).

With the proper controls on counterfeiting, fiat money has a seemingly perfect set of characteristics. Fiat money is of known value, lightweight,