14: Money as a Medium of Exchange
Babbage switches rather abruptly to the topic of money, as it is a necessary element to commerce in a economy that has grown and evolved beyond the most basic levels of trade.
In a sparsely populated area where there is little trade, most households are self-sufficient and produce all that is needed for their own consumption. Trade is occasional, and only necessary where they have produced excess or where there is something they cannot produce for themselves, given their skills and resources.
But as civilizations evolve, households specialize in production: a farmer may raise a single crop such as cotton, and trades most of his product to others who specialize in producing other goods. Frequent exchanges of dissimilar goods require a common medium of exchange, as bartering becomes highly time-consuming.
This common medium of exchange often took the form of a good that was useful to all - such as wheat or salt - and in some occasions a commodity that was not useful at all except as a medium of exchange, such as shells or pelts. Most civilized nations eventually evolved into trade in metals - whether useful metal such as iron or copper or precious ones such as gold or silver.
The creation of coinage - standardized pieces of metal of a given grade and weight - began as a private industry but is quite often taken over by government, at first as a means to facilitate trade and avoid dispute over the purity and weight of pieces of money, to ensure the legitimacy of paper money, and by other means to prevent fraud.
He briefly mentions seignorage, the fee collected for the task of creating money, and the manner in which it changed from trading less coin for raw metal to trading pieces of metal that had been debased - and how the practice of debasing tends to get out of control - but quickly departs this topic. But it does serve to explain how the present-day currency differs from the quantity on which it was originally based: a "pound note" was once a note that could be redeemed for a pound of silver, but due to debasement became a unit of currency that did not correspond to the actual amount of the money commodity it originally represented.
In direct barter, the value of the two goods being exchanged were valued against one another - a baker might exchange four loaves of bread for a pound of meat. In a money economy, the value of all things are reckoned in terms of money - bread is worth one coin and meat is worth four coins. But the variations in value remain: one butcher may sell meat for five coins and another for four, just as they might agree to different numbers of loaves.
He then switches to the idea of paper money, which was originally done for convenience. For larger purchases, such as exchange between merchants or producers, the amount of metal was burdensome and it was sufficient to provide a note that could be redeemed at a bank (hence the term "bank note") for the currency - or if both parties had accounts at the same bank, ownership of the metal could be transferred between accounts and the metal would never leave the vault.
The banking business often aggregated transactions and transferred metals among themselves rather than requiring their customers to withdraw it from one and deposit it at another. In many instances, notes could simply cancel one another out: if bank A owed ten pounds to bank B and bank B owed ten to bank A, they would simply exchange the notes and the accounting could be done internally.
The growth of banking made all of this complex, and it was simplified by the clearing house - an independent firm that would gather and sort the checks from various banks to cancel out as much of the metal transfer as possible by matching notes and the business of a day could be simplified so that "scarcely any coin" would end up being exchanged. In a large city, such as London, the function of the clearing house saved much labor in sending a fleet of clerks scurrying from one bank to another.
Naturally, government found its way into this business as well, issuing notes against a government reserve and managing the exchange of notes among banks. It is in the same way that government involves itself in the exchange of real estate or any other property - maintaining a central registry to increase convenience and decrease fraud, while collecting the customary fees for managing the exchanges.
However, in the case of coin or paper, government soon yielded to its own greed and became the very perpetrator of the fraud it was instituted to prevent: it would debase money by alloying coin, so that it contained less precious metal than face value, and it would issue paper money without the metal to back it. And because it was government, there was no force other than a revolt that would punish it, and it could use its might to threaten the citizens into using currency that they knew to be worthless.
Back to practical matters: every person in a civilized country uses a certain quantity of money. He receives it in exchange for goods and services he provides to some and uses it to purchase the goods and services he obtains from others. It's in this manner that a single coin passes from hand to hand: from the shop owner to his clerk, the clerk to his grocer, the grocer to the farmer, the farmer to the blacksmith, and so on.
With this in mind, it is of particular importance to recognize that the wealth of a society is not measured by the amount of money it has, but by the amount of exchanges that occur. In the previous example, five parties have benefitted from the circulation of a single coin. The same coin, resting in a purse and not spent, creates no value to anyone.
Also, the supply of money must be sufficient to both needs: one amount is needed to conduct routine transactions and is in constant circulation, an another amount is needed for those who set it aside for future use, which does not circulate.
There is some concern over the supply of money - and fear that economic activity will be stifled by the lack of money available in circulation to support the necessary transactions. This is reduced in part by the use of paper money, as the physical coin is not necessary until notes are reconciled, but it also creates an effect of increasing or decreasing the value of coin according to supply and demand.
Just as with any other good, when there is a shortage of silver coins in a market, they become more precious and demand more goods and exchange - and where there is a surplus, they become less precious and command less goods in exchange. This is of great concern to those who hoard money, as they expect that the seven pounds of silver they keep in a vault will have the same purchasing power it did when they earned it.
Most people, however, have little interest in hoarding money and spend what they get in short order. The judicious man will maintain a small reserve to protect himself from misfortunes, and the miser will horde a great deal that will not be spent until his demise. But for money in circulation, the inflation and deflation have negligible effects because prices in trade balance one another out if they are exchanged in short order. It is only the hoarders of money who gain or lose value when the money increases or decreases in value.
The greatest cause of shortages of money are exchanges between markets - whether neighboring towns or nations - when the citizens of one market demand more actual goods of another market than they provide in return, the money moves permanently from one market to another. And as stated, this is of greatest concern to those who hoard money, and who are fearful of fluctuations in its value.
(EN: It is also of concern for the worker, whose employer arbitrarily adjusts his wage. If prices increase, the employer earns more money and should return and equal portion to his employees - but many prefer to keep wages the same and consider the difference to be their profit. Meanwhile, the purchasing power of their workers decreases. Over the long term, the workers will leave an employer to seek fair compensation - but until they find a fair deal, they suffer for being thus robbed by their employers.)