All About Commodity Money

Posted by Allison on 6 April 2009, 15:27

The currencies we use today are known as fiat money – that is, they have no actual value.  They are not backed by anything and they don't represent anything either, so they are really worthless.  A scary thought when you have bills to pay!

Commodity money, on the other hand, is completely different.  It has a value since it is either made from something which has that value, or it is backed by something which has value.  So for example, I might release a new currency that I determined was backed by diamonds.  A one unit note would be backed by a single diamond of a certain predetermined size, while a five unit note would be backed by five diamonds of that size, and so on.

What this means is that if you came to me with some notes to the value of twenty diamonds, you could demand that you hand me your banknotes and I would give you twenty diamonds in return.  This is commodity money.

Commodity money is no longer in existence in the modern world, but it was the only kind of currency known in ancient times.  The idea of having a currency of no value would have been thought of as very odd (as in fact some people do today).

Because commodity money is made of or backed by something that is deemed to have real and lasting value, there is naturally a limit to how much of it we could have as a country if we chose to go back to the days when commodity money was commonplace.  For example, gold needs to be mined so if this was the material that our coins were made from then we could only make as many coins as we could get from the amount of gold we had.  If we wanted more then we would have to go and mine for more.

Commodity money had its own advantages and disadvantages in times gone by however.  One main advantage was that commodity money consisted of more than just one type of object.  By definition, a commodity is something that is bought and sold, rather than simply being a form of money in itself.  This means that many different items can be viewed as being commodities, depending on who wants them and who has them to sell.

This was certainly the case in ancient times, when people used items such as live cattle, beans, grain and other such items to make trades with other people.  Anything that was deemed to have value and was desired by others could be used as commodity money.

So how does this compare to our modern currencies?

Well for one thing, fiat money as it is known always becomes defunct sooner or later.  Because it has no value, inflation can have a devastating effect on it over time, and history is scattered with examples of this.  Commodity money isn't affected in the same way, and when you start delving into what it really means to use commodity money you can start to see the truth in this.

Let's take gold as an example.  Gold has always had value, since it is a precious metal and it is a well known fact that it cannot be made by man.  We cannot manufacture it, so we must simply look for it where it occurs naturally.  The fact that there is a limited supply of it means that it holds its value.  This is in direct contrast to the fact that any government today could choose to manufacture endless amounts of their own currency and flood the market with it, since they are made of nothing more than paper, non-precious metals and other materials.

As a rule anything which is scarce tends to have a higher value placed upon it.  You might think that grain and cattle weren't exactly scarce in times gone by, but you still would have had to raise the cattle and grow that grain to be able to use them to trade with other people, and if your crop of grains was ruined for any reason, your one method of trading would have been ruined too.

The one thing that really stands out as a disadvantage of commodity currencies is that they tend to have distinct borders.  If you had a large amount of grain that you wanted to trade for a cow, for example, you would have to find someone who wanted to take that grain.  If every single other person you knew had no use for grain, then you wouldn't be able to make your trade.

At the end of the day, if all the currencies in the world at present ceased to exist, we would all look towards the things which had real value so we could continue to trade to get the things we need for our everyday lives.  We would naturally look towards gold and silver, and other things which have value.  Bearing this in mind, you might think that there are still some forms of commodity money in use today, albeit in a very small sense of the word.  For example, if you have a skill that people will gladly pay money for, you might offer to do something for someone if they gave you food in return.  Your skill acts as a commodity and so the exchange is made.

The world of money and currencies seems like a fairly straightforward one until you start looking into it more deeply.  While commodity money isn't widely used in any country at the moment, could we see a return to it in the future?  It's certainly a distinct possibility, although one wonders how the world will change as a result.

Could we return to the days where we traded grain, beans and other items for what we wanted and needed?  Or are we too advanced for that now?  If fiat money collapses we may not have a choice at all.



  1. This was a fascinating article! I love reading as much as I can get my hands on with regard to money and currency. It’s something of a hobby with me and I think the differences between how we handle money today compared with hundreds of years ago are fascinating. I wonder how things will be in years to come though, if we even still have a hard currency at all. It does make you wonder.

    — David · Sep 29, 08:04 PM · #

  2. Interesting. I’ve just read that the Republicans in the US want to think about getting the Gold Standard back. As I understand it that’s the opposite of fiat money, i.e. worthless money. Wonder if the US dollar will be backed by gold again in my lifetime? Somehow I can’t see it, but you never know.

    — Jez · Sep 17, 10:41 AM · #