After barter systems, the next major shift came by accepting commodities as a medium of exchange, which had limited intrinsic value on its own, however, fulfilled a superior role as a currency. Cowrie shells is one historical example. As long as everyone accepts them, and their natural supply is limited, such system works sufficiently well.

Metals, of course, are the best known examples of such systems that have served well for many centuries. Today, the gold price tends to increase during times of turbulence, and it acts as a safe haven because the public perception is that gold is a solid store of value, which has been engraved in the minds of people since childhood.

People believe that gold is a good store of value because this idea has been engraved in their minds since childhood.

In practice, however, gold and silver prices have been very volatile and were often significantly affected by supply/demand factors. One famous example is the increase in gold and silver supply after discovery of America, causing a significant increase in inflation. Counterfeiting has been an issue ever since the widespread use of gold and other precious metals began and, of course, the content of gold in the actual metal has been a source of manipulation by people and authorities for centuries.

It is important to note that gold, for instance, has limited intrinsic value on its own, compared to barter goods used as medium of exchange, and its value is largely based on the trust and public perception of gold or any other metal being a secure store of value. The fact that gold has been around for so long is, perhaps, the single most important aspect supporting its use. Today most central banks still hold gold in their books to provide comfort to their citizens even though there is little practical reason to do so, given that gold has low interest rates and significant storage costs.

The next development phase took place when metal coins were introduced with specific weight and value characteristics serving as a standardized measure of value and unit of account. After coins came the introduction of paper money — first in China and later also in Europe, often through promissory notes. The ability to move from coins to paper money was, again, driven by technology, starting with paper production in China. Paper money represented a more convenient and lighter way to carry value around and enable trade on a wider territory. It was also influenced by social set-up, authorities, laws and their implementation. However, risks of counterfeiting also increased.

As soon as paper currency became widely established, currency issuers had the temptation to issue it more than necessary since the cost of banknote production was just a small fraction of its value as a medium of exchange (e.g., the cost of production of a USD 100 bill is 13.2 cents). Initially paper currency was typically tied to gold or silver, then with time the connection was gradually softened and later removed completely, leading to an increase in inflation and sometimes to hyperinflation.

Currency issuers have been tempted to print more money than necessary, in the worst case scenario leading to hyperinflation.

The issuance of currency also brings financial benefits to the issuer. Depending on the structure and the system, central banks make profit and these profits are partially distributed back to the shareholders. Seigniorage is the term describing profit made by a government by issuing currency, especially the difference between the face value of coins and banknotes and their production cost. Seigniorage profits are typically part of central bank’s and government revenues and are used according to the needs and budget plan. People can influence profit distribution only indirectly, if at all. Even in democratic countries central bank independence limits the governments’ abilities to influence central bank finances.

Modern currencies, developed after the 1970s, were not backed by any single asset. Major currencies did not have any physical backing while other countries often linked their currencies against major industrial currencies that became so called “reserve” currencies. This led to a situation where central banks and their governing councils became key economic authorities, globally bringing new importance to the general role of central banks and its independence from the government.

With the change in central bank focus and the development of IT technology, the way currency was “produced” changed. The role of physical currency has been diminishing and the role of digital currency has increased. Digital currency dominates the physical currency several times and has the ability to eliminate physical currency completely, thereby reducing friction in the economy. Physical currency is more a habit than a need in modern economies with developed infrastructure and technology. At the same time, the cost of production for digital currencies is even lower than that of the physical currency thereby exaggerating the temptation to issue it in excess of what is required — and, of course, it is very hard to tell what is required.

Quantitative easing pursued by major global central banks after the great recession, was one example how central banks issued electronic currency in huge quantities by buying up government and corporate debt. It was equivalent to printing money without actually “printing” it and, of course, without any backing. It was all about trust.