The eras of money

Commodity money is money that is also a useful or desired thing in its own right. Over thousands of years people used cowrie shells, grain, salt, cattle, cloth, beads, tobacco and metal tools. Cowrie shells, gathered mainly in the Indian Ocean, circulated across parts of Asia and Africa for an extraordinarily long time.

Why these goods worked

Good commodity money shared a few qualities. It was durable enough not to spoil quickly, portable enough to carry, divisible into smaller amounts, and recognisable, so that people could check it without expert help. Most importantly, many people wanted it, so accepting it was a safe bet: you could pass it on to someone else.

Credit came first, not barter

School textbooks often describe a world of pure barter that money then replaced. Anthropologists have found little evidence of such a world. In small communities, people more commonly kept informal records of favours and debts and settled them later. Records from Mesopotamia show temple and palace officials keeping accounts in units of barley and silver, even when little physical silver changed hands.

This matters for the rest of the story. From the beginning, money was as much a system of records and promises as a pile of objects.

The limits

• No two cattle, sacks of grain or bolts of cloth were exactly alike, so prices were hard to compare.
• Supply depended on harvests, herds and lucky finds, so the amount of money could swing for reasons unrelated to the economy's needs.
• Large payments over long distances were slow and risky.

What changed: Value became something people could carry and count, not just remember.

Before coins, metal was already used as money by weight. In Mesopotamia the shekel was originally a unit of weight for silver, and payments meant putting metal on a balance. That worked, but every transaction needed scales and some way of testing purity.

A stamp as a promise

Around the late seventh or early sixth century BCE, in the kingdom of Lydia in western Anatolia, pieces of electrum, a natural mix of gold and silver, began to carry official marks. The mark said, in effect, that the issuer vouched for the weight and quality. Within a few generations Greek cities were striking their own silver coins, and coinage spread around the Mediterranean. In China, bronze money cast in the shape of tools and later round coins with square holes developed separately.

Coins made small everyday payments far easier. They also gave rulers a new source of income, known as seigniorage: the difference between the cost of making coins and the value at which they circulated.

Debasement, the oldest monetary temptation

Because a coin's acceptance rested partly on the stamp, issuers could quietly reduce the precious metal inside it. Roman emperors under financial pressure did exactly this. Over the third century CE the silver content of the main Roman coin fell to a small fraction of its earlier level, and prices rose steeply as people adjusted.

England had its own episode. In the 1540s Henry VIII reduced the silver in English coins sharply, a period later called the Great Debasement. Elizabeth I's government restored the coinage from 1560, recalling and reminting the debased pieces.

That last effect is often summarised as Gresham's law, after the Tudor financier Thomas Gresham: when two coins have the same face value but different metal content, people spend the worse one and keep the better one.

What changed: Trust moved from the metal itself to the reputation of whoever issued the coin.

Heavy coins were awkward for large payments. In Sichuan, under the Song dynasty, merchants began issuing paper receipts for deposits of iron coins. In the early 1020s the state took over the issue of these notes, known as jiaozi, which makes them among the earliest government-issued paper money.

Later Chinese dynasties issued paper on a large scale, and several of them issued too much. The result was a recurring pattern of rising prices and loss of confidence, and by the 15th century the Ming state had largely moved back to silver.

Europe: from receipts to bank notes

In Europe, merchants used bills of exchange from the medieval period to move value between trading cities without carrying coin. In 17th-century London, goldsmiths took deposits of coin and gave receipts, and those receipts started to circulate as payment. Stockholm's Banco, a forerunner of Sweden's central bank, issued Europe's first bank notes in the 1660s.

The Bank of England was founded in 1694 to lend to the government during war with France. It issued notes promising to pay the bearer in coin, and over the following centuries became the centre of the British monetary system.

When paper outran its promise

Paper money was cheap to produce, which made it tempting to over-issue. In France around 1716 to 1720, the Scottish financier John Law ran a state-backed bank whose notes were linked to shares in a trading company. When confidence turned, the notes and the shares lost most of their value within months. Later, the French revolutionary assignats lost value rapidly in the 1790s.

Even sound issuers could suspend payment. Between 1797 and 1821, under the strain of war, the Bank of England stopped paying out gold for its notes. Notes remained in use throughout, a reminder that acceptance can rest on habit and law as well as on metal.

What changed: Money became a written promise, separate from the metal it claimed to represent.

Under a gold standard, a currency is defined as a fixed weight of gold and notes can be exchanged for gold at that rate. Britain moved to gold in practice in the 18th century and formally after the Napoleonic Wars, resuming full convertibility of Bank of England notes in 1821.

In the 1870s Germany adopted gold, and other countries, including the United States, followed over the next decades. When two currencies are each fixed to gold, they are also fixed to each other. For about four decades before 1914, much of the world's trade and lending took place within this shared framework, with London at its centre.

How the system kept itself in balance

In theory, gold flowed between countries to settle trade imbalances. A country importing more than it exported would lose gold, its money supply would shrink, prices would fall, and its goods would become cheaper abroad until the imbalance closed. In practice central banks, led by the Bank of England, also changed interest rates to attract or release gold.

The costs

• The money supply depended on gold discoveries. Prices fell for long stretches in the late 19th century, which was hard on borrowers, and rose after large finds in South Africa and elsewhere.
• Countries could not easily cut interest rates or expand money in a slump without risking their gold reserves.
• Adjustment through falling prices and wages was slow and painful for ordinary households.

Collapse between the wars

The First World War suspended the system. Britain returned to gold in 1925 at the pre-war rate, a choice many historians see as too high, and left again in September 1931. The United States changed the dollar's gold value in 1934. During the Great Depression, countries that left gold earlier generally began to recover sooner, a pattern economic historians have documented in detail.

What changed: National currencies were tied together through one shared anchor, and that anchor proved too rigid for a crisis.

In July 1944, delegates from 44 allied nations met at Bretton Woods, New Hampshire, to design the post-war monetary order. The British delegation was led by the economist John Maynard Keynes, and the American one by Harry Dexter White. Their goal was stability without the rigidity that had broken the gold standard.

The design

Members fixed their currencies to the US dollar, with a narrow band around each parity. The dollar, in turn, was convertible into gold for foreign governments and central banks at 35 dollars per troy ounce. Exchange rates could be adjusted, but only to correct what the agreement called a fundamental disequilibrium.

The conference also created the International Monetary Fund, to lend to members facing short-term payment problems, and the International Bank for Reconstruction and Development, later part of the World Bank group.

The strain

As world trade grew, other countries needed more dollars to use and hold as reserves. Those dollars came from American spending and lending abroad. By the 1960s the dollars held outside the United States exceeded the US gold stock. The economist Robert Triffin pointed out the dilemma: the system needed a growing supply of dollars, yet every extra dollar abroad made the promise to convert into gold less believable.

Sterling came under repeated pressure too, and in November 1967 the British government devalued the pound from 2.80 to 2.40 dollars.

What changed: The dollar became the hub through which other currencies connected to gold, and the hub carried the system's weight alone.

On 15 August 1971 President Nixon announced that the United States would suspend the convertibility of the dollar into gold. An attempt to rebuild fixed rates at new levels, the Smithsonian Agreement of December 1971, did not last. Sterling was floated in June 1972, and by March 1973 the main currencies were floating against each other.

What fiat means

Fiat money is money because the state declares it legal tender and because people expect others to keep accepting it. It is not redeemable for gold or any other commodity. Today almost all national currencies are fiat currencies.

Most fiat money is not cash. It is created when commercial banks make loans and credit borrowers' accounts, a process the Bank of England described in a widely read 2014 bulletin article. Central banks influence the whole system mainly by setting short-term interest rates.

The search for a new anchor

The 1970s brought high inflation in many countries, including the UK, where annual inflation peaked above 20 per cent in the middle of the decade. Over the following years, governments tried different anchors: targets for the money supply, links to other currencies, and eventually explicit inflation targets.

• New Zealand introduced a formal inflation target in 1990, and many central banks followed.
• The UK adopted inflation targeting in October 1992, after leaving the European Exchange Rate Mechanism.
• In 1997 the Bank of England gained operational independence to set interest rates, with the target set by the government.

Floating rates moved adjustment from slow changes in prices and wages to the exchange rate itself, which can move quickly. Some countries chose not to float and kept pegs or currency boards; the currencies page looks at those choices.

What changed: The anchor moved from metal to institutions, mandates and published rules.

The shift to digital money began long before smartphones. Charge cards appeared in the United States in the 1950s, and the first UK credit card was launched in 1966. The world's first cash machine went into service in north London in 1967. Electronic interbank systems followed, including the UK's Bacs scheme in the late 1960s, CHAPS for high-value payments in 1984, and Faster Payments in 2008.

Public money and private money

To understand today's debates, it helps to separate two kinds of money. Banknotes are public money: a direct claim on the central bank. A bank balance is private money: a claim on a commercial bank, protected in the UK up to a limit by a deposit protection scheme. Most people use both every day without noticing the difference, because the two are exchangeable one for one.

Why central banks are researching digital currency

As cash use falls, some central banks have asked whether the public should still have access to a form of central bank money. A central bank digital currency, or CBDC, would be a digital version of that public money. Several countries have run pilots, and a few small economies have launched one.

In the UK, the Bank of England and HM Treasury published a consultation in 2023 on a possible digital pound and have continued design work. They have said that any decision to introduce one would come later and would require legislation. Questions under study include privacy, limits on how much one person could hold, and effects on bank lending.

Alongside this, privately issued cryptoassets and so-called stablecoins have prompted new rules and research. We discuss them only as part of monetary history and do not comment on any individual asset.

What changed: The central question is no longer what money is made of, but who keeps the ledger and on what terms.