Why Does Money Have Value? Not Because the Government Says It Does.
Why does the dollar bill in our pockets have value? According to some commentators, money has value because the government in power says so. For other commentators the value of money is on account of social convention. What this implies is that money has value because it is accepted, and why is it accepted? … because it is accepted! Obviously, this is not a good explanation of why money has value.1
The difference between Money and Other Goods
Now, demand for a good arises from its perceived benefit. For instance, people demand food because of the nourishment it offers them once consumed. This is not so with respect to money. According to Murray N. Rothbard,
Money, per se, cannot be consumed and cannot be used directly as a producers’ good in the productive process. Money per se is therefore unproductive; it is dead stock and produces nothing.2
Why, then, is there demand for money? Why do individuals desire to have something which cannot be consumed and produces nothing? To provide an answer to this one must go back in time to establish how money emerged.
In trying to improve their lives and well-being, individuals discovered that by replacing direct exchange, where individuals exchange one good for another good, with indirect exchange they could enhance the marketability of their produce. The introduction of indirect exchange means that the produce of an individual is exchanged for some more marketable good and then this good is exchanged for the produce of another individual.
The key to a good’s emergence as a mediator of indirect exchange is that it must be widely accepted. On this, Ludwig von Mises observed that, over time,
there would be an inevitable tendency for the less marketable of the series of goods used as media of exchange to be one by one rejected until at last only a single commodity remained, which was universally employed as a medium of exchange; in a word, money.3
Similarly, Murray Rothbard wrote that,
Just as in nature, there is a great variety of skills and resources, so there is a variety in the marketability of goods. Some goods are more widely demanded than others, some are more divisible into smaller units without loss of value, some more durable over long periods of time, some more transportable over large distances. All of these advantages make for greater marketability. It is clear that in every society, the most marketable goods will be gradually selected as the media for exchange. As they are more and more selected as media, the demand for them increases because of this use, and so they become even more marketable. The result is a reinforcing spiral: more marketability causes wider use as a medium, which causes more marketability, etc. Eventually, one or two commodities are used as general media—in almost all exchanges—and these are called money.4
Through the ongoing process of selection, people settled on gold as their preferred general medium of exchange. By means of money, individuals can make goods they have produced more marketable. Thus, a butcher can now trade with a vegetarian shoemaker. The butcher can exchange his meat for money and then exchange the money for shoes.
What makes goods more marketable is the wide acceptance of money by individuals. What gives rise to this acceptance is that money has a purchasing power, i.e., a price. People demand money because it has purchasing power. How does a thing that serves as the medium of exchange acquire its purchasing power—its price in terms of other goods?
We know that the law of supply and demand ex
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