[halhen]

> how do you do it?

In Capital volume 1, Marx paints the following logical progression. Whether it carries any historical truth, I don't know. (Note: there are many more nuances to it, and you perhaps need to wrestle the original source to get it all)

To establish a single unit of measurement:

a. The simple, isolated, or accidental form of value: Commodities are exchangeable with other commodities, e.g. 20 yards of linen = 1 coat.

b. The Total or Expanded Form of Value: a commodity is exchangeable with any other commodity, e.g. 20 yards of linen = 1 coat or = 10 lb tea or = 40 lb coffee or = 1 quarter of corn or = 2 ounces of gold or = etc.

c. The general form of value: Any of said quantities of commodities are exchangeable with the original commodity, e.g. 1 coat, 10 lb tea, 40 lb coffee, 1 quarter of corn, and 2 ounces of gold, are worth 20 yards of linen.

d. The money form: One, or a few, commodities become either the de factor or the legal "universal equivalent" commodity in which exchange-value is measured. This universal requires some properties (I'm sure I have forgotten several):

* It must be uniform. Not all horses are equal, so horses are no good.

* It must be divisible and capable of quantitative differentiation. Half a work horse is less worth than half of a whole, and two halves of work horses does not equal one. Horses are not good for a second reason.

* As trade expands geographically, the value of the universal equivalent needs to be universally recognized. Horses for seamen? More inconvenient than it should be.

* The universal equivalent should not deteriorate. Horses die. They really are no good for this.

Instead, precious metals fulfill these qualities. And just as we use dollars and cents, gold and silver can be used to differentiate between different magnitudes of value. (Note: gold and silver still has values as commodities, which determine the amount of stuff you get for them. See the initial points.)

Still, they do have some problems. They require measurements and tools to divide. It's not really convenient to go into Starbucks with a lump of silver to carve the price for a coffee.

So coins are minted, containing the proper amount of each metal. New problems arise. Cheaters carve metals from the coins to melt and create new. Wear and tear cheapens the coins. So bills and coins are created as symbols of silver and gold, but backed by them. The actual precious metal reside elsewhere, and the bill is just a proof of ownership.

Now, those countries and owners who control precious metals get significant power. They can withhold or flood the marked at their whim. No good, says the other countries. So when currency is sufficiently recognized as a means of payment, one can remove the actual backing and keep the bills and coins only. And while we're on it, why bother with the bills at all? A balance in a computer is just as good, right?

[nhaehnle]

This is a pretty good summary, except that there is quite a lot of doubt by anthropologists that the historical succession ever happened like this. Apparently, various forms of money came into being out of debt, without the detour via precious metals.

The reasoning is roughly this: When you trade, it is extremely rare for a "double coincidence of wants" to actually happen with real goods at a fixed point in space and time. So people extend credit and remember who owes what to whom. Money then grows out of the increasing formalization of this process. Coins are then created by a state that wants to make lots of uniform payments (i.e. payment to soldiers, hence the name soldi for certain Roman coins).

[javajosh]

There is an interesting twist here that relates to the reflexivity (reflexivity, that thing Soros likes to talk about) of the value of gold. Precious metals may start off being precious because they are rare and beautiful materials that are easily crafted into decorative shapes. Girls like it. Guys like it. But then, because it doesn't decay it's value increases because it starts to be used as a standard trading commodity! Because that pile of gold can be converted into a house or food for a year or a farm, etc. that pile of gold increases in value. Indeed, pretty quickly this reflexive value eclipses intrinsic value, to the point where the gold itself doesn't matter except as a placeholder.

We can then jump to fiat currency. The key question is: how much real wealth can that pile of fiat money be converted into? The details vary (e.g. you can negotiate a better price) but fundamentally the real-world convertibility of a currency requires a functional, working market: the US dollar is powerful because you can easily and stably convert it into a basket of real goods. Indeed, the sheer size of the US economy means that this basket is unusually independent of demand, and can meet essentially unlimited demand in real goods. I mean, you could probably buy $100M of US corn today and not have any real effect on the supply. (Yes, you could overwhelm almost any single commodity market with $36B. Luckily Bill Gates did not decide to blow it all on bottled Coke, otherwise the world would be totally without Coke for probably a good two weeks!)

It is the physical, political, social, and legal environment that defines the machinery with which money is converted into real goods. Indeed, one could even justify US geopolitical goals (which pretty much boil down to "become invulnerable") as making possible the ultimately stable marketplace, which further strengthens the currency.

The problems arise, of course, when the machinery itself becomes perverted. We can define market perversion as "adversely affecting the machinery that converts money into real goods". There are a wide variety of such perversions, ranging from patent trolling (which perverts the R&D market), to the increase in size and complexity of the legal system to the point where prosecution is itself punishment (which also dampens innovation and reduces risk taking). This is partly why it is important to have a healthy middle class and not have too much concentration of wealth: if wealth is concentrated enough, then the wealthy wed with the machinery, and the perversion becomes systematic. We already see that with telecom and the FCC, banks and the SEC.