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By Root 818 0

trading goods and forming societies, the method of trade was direct exchange, or barter. Persons who wished to engage in trade had to come across a double coincidence of wants; if you produced apples and wanted oranges, you had to find someone who produced oranges and wanted apples. This system was obviously cumbersome and inefficient. What happens if the orange farmer did not want apples? Then the apple farmer was out of luck. Also, it is very difficult for producers to calculate their profits, how well they were engaging in trade, and how much each good was actually worth. Moreover, apples only stay fresh for a few weeks and are only produced at certain times of the year, so the apple farmer is forced to flood the market with all of his excess apples. Apples are, in other words, a poor store of economic value.

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Gold Is the Gold Standard of Currencies

Humans responded to these inefficiencies by using goods that were in very high demand, durable, easily divisible, available in large quantities, and hard to produce (or counterfeit) as a universal medium of exchange, or a currency. In this system, the producer trades not for goods with the immediate intention of consuming them, but with the intention of trading them for other goods which he may consume at a later time. To use a simple example, consider the use of cigarettes as a medium of exchange amongst inmates in prisons. Not every prisoner who collects cigarettes smokes them, but the prison population’s demand for cigarettes is so high that they can always be traded for practically anything available within the prison’s walls.

Over time, the best mediums of exchange became gold and silver. Both of these metals were attractive because they have always had a high value-to-weight ratio, are very durable, are difficult to counterfeit, and are easily divisible. Also, neither metal could be easily produced, since mining them was and is a slow process. Throughout history individuals remained calmly assured that the two metals’ value would remain stable if they wished to save their profits for future consumption, rather than consume them all at once.

Fool’s Gold

A goldsmith’s original job was to transform the gold that was extracted from the earth into coins of equal weight and value. They had very secure buildings in which to store the gold, safe from the reach of thieves. Since people also began to stockpile these highly valuable metals for future security, they, too, had to protect their gold from thieves, and to keep their gold in the goldsmiths’ vaults (for a fee, of course). This was a very lucrative business for the goldsmith. When people deposited their gold in the goldsmiths’ vaults, in return they received a certificate which was a claim for the amount of gold they had stored in the vaults; not the very same gold which they brought to the goldsmith, but its precise equivalent. Since it was very inconvenient to go back and forth continually to the goldsmiths’ vaults to claim your gold in order to trade at the market, people started leaving their gold in the vaults and trading the claim certificates.

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Goldsmiths started realizing this, and saw an opportunity. If most people were leaving their gold in the vaults for safekeeping, goldsmiths typically did not have to worry about exchanging all of the gold in their vaults for the claim checks at once. Thus, they could start loaning out claim checks for a fee (i.e., interest payment), for more gold than they actually had in their vaults. If someone wanted to claim his own gold, or see if there was gold in the vault, there was still a significant amount there to make good on the small day-today transactions. When people became aware of this fraud, they panicked and frequently rushed to the goldsmith to claim their gold (this panic is now commonly known as a bank run), only to find out they were conned, and there was not enough gold to be claimed for all the outstanding claim checks. People were furious to have been robbed of their hard-earned gold; furious because their natural rights to property had been violated.