Something funny—or at least unusual—seems to be going on in the world of money. We’re besieged by headlines about Bitcoin. Facebook plans to launch a digital currency for its near-three billion users. Central banks around the world are also exploring setting up new digital tenders, even as they’ve been creating conventional money at record rates during the pandemic. In the face of all this, you don’t need a philosophical bent to start asking deep questions. What even is money? Where does its value come from?
In grappling with these queries, I decided to ask my six-year-old son what he thought money was. “Gold,” came the confident answer. It turns out that he was thinking of pound coins, which look slightly golden even if there’s no precious metal in them. Nevertheless, he gave an answer that has a very long lineage—and which some regard as still essentially true.
The traditional story told by economists is that money emerged because people bartered (I’ve got wheat and you’ve got fish, let’s swap) but found the process inefficient: you might not have what I want, at least not before my stuff becomes inedible. So they decided to use shiny and relatively rare objects to facilitate transactions. Money is essentially precious metal, the “metallist” says, which explains why we have exchanged gold and silver coins as payment for millennia and, in recent centuries, why we’ve often underpinned our paper money systems with gold standards.
The last official gold standard expired 50 years ago this summer, when President Nixon stopped allowing the conversion of dollars into the metal. Money has been anchored in little beyond the promises of those who issue it ever since—and some metallists maintain the Nixonian break with gold is exactly the moment where things started to go wrong for the world economy, unleashing the furies of inflation and financial instability.
There’s a problem with metallism, though. Anthropologists have determined that money didn’t, in fact, arise as a handy replacement for bartering. Its earliest forms seem to have been products of ritual rather than necessity. And another school of thought—chartalism—draws on this history to argue that money is essentially a creature of power, not the market: governments force us to pay our taxes in a certain currency and that’s what creates demand and underpins its value.
The metallists and the chartalists are both half right. Modern state money is undoubtedly a political institution. Yet it’s also often been underpinned by faith in the enduring, intrinsic value of gold.
So where does Bitcoin fit in? Some see it as a “digital gold” thanks to its fixed supply: the underlying code dictates that only 21m tokens will ever be produced. Yet the truth is that Bitcoin is not very useful as money.
The classic economic definition of money is three-fold: it’s a “unit of account” in which to quote everyday prices, a “medium of exchange” that everyone accepts for payment, and a “store of value” you can preserve your wealth in. Bitcoin doesn’t perform the first two functions. Granted, it’s been a wonderful store of value if you bought some two years ago, thanks to explosive price gains. Yet the same was true of tulips when a mania for them gripped 17th-century Holland—until suddenly it wasn’t.
One reason libertarians are attracted to Bitcoin is its “blockchain” technology, which makes it a decentralised network, sustained by users’ computing power rather than controlled by governments or central banks. Yet central banks are adopting and adapting blockchain tech themselves. Chartalism too is going digital.
So what do you really need to know about money? I also asked my eight-year-old daughter what it was. Her refreshingly non-theoretical and non-ideological answer: “Something you use to buy things,” which sounds about right. Money is a tool, not an investment. There can be better or worse versions of it. It can change its form over time. It can be public or private. Its value stems from our collective faith in the stability of the network it creates. If the stability goes—through rampant inflation, political collapse or some digital design flaw—so will that belief. Money has to be useful. It’s a means, not an end.
This piece was published in Prospect magazine on 4 June 2021