5.000 years ago humanity observed that bright metal, yellowish, dense, dificult to acumulate, very scarce, and that did not change with the passing of time, it was the natural candidate to mesaure the value of the commercial transactions and also to acumulate richness of the surplus of production. A better way has not been discovered or invented for this task yet.
Money must meet three main functions in the economy:
As a way of exchange to avoid problems of barter. Money should be a light good in relation to its value, easy to store and transport, and difficult to destroy.
Accounting unit: When the value of a good is often used to measure and compare the value of other assets or when its value is used to denominate debts. The unit of account is the unit of measure used in an economy to fix prices.
Preservation of value: When a good is acquired in order to preserve the commercial value for future exchange, then it is being used as a storage of value. Gold and silver retain their properties despite the passing of time. They are a way of accumulation or hoarding. Money, as a representative of wealth, has the power to buy any goods and it can be stored in any quantity. In other words, the function of hoarding can only be performed by money of full value: coins and bullion, precious stones, gold objects, etc. The goods chosen as a means of accumulation should always be something that can be stored for long periods without deterioration. Money is a storage of value but not the only one, any asset that keeps its purchasing power over time serves as a storage of value.
Moreover, money must be recognized by the society that uses it, allowing its identification and assessment very clearly. The coinage was a logical invention, as evidenced by its nearly three millennia of existence.
The first coins were a very homogeneous composition, weight and purity remained fixed, as in the case of the drachma issued in Athens in the sixth century BC, containing around 65-67 grams of fine silver. However, the state monopoly of coinage (from the Old State) allowed the government to order filing or trim manufactured coins before being in circulation to remove part of the precious metal that they contained. The authorities that issued them were tempted to reduce the quality of the coinage to create more money at the expense of reducing the precious metal content of the new coins in circulation. Currencies made of current metals and harder as bronze or copper metals were, in fact, trust money whose value depended mainly on the number of gold or silver for which they could be exchanged. Gold and silver coins used to circulate outside the country that issued them because of its intrinsic value. For example, the Spanish silver peso, made from America’ s mines, became a common currency in China from the sixteenth century.
Once created, the coins originated a monetary system whose features have remained essentially constant for millennia. One of the developments that has endured was the introduction of the slots at the edges in the European currencies during the seventeenth century in order to detect easily weathering and to prevent its filing.
Features of gold coins as a way of payment:
The great value that gold coins represent in relation to their weight and volume (density value).
Unanimously recognition as a way of payment, undoubted quality.
Its divisibility allows to split its value in an unlimited way.
The difficulty to fake them.
Paper money was first introduced in China around the ninth century, as money in cash exchangeable by certificates issued by the government. Backed by the powerful authority of the Chinese state, this money retained its value throughout the empire, thus avoiding the need to transport the heavy silver over long distances. It first appeared in the West in the sixteenth century, when they started to issue bank notes money to support customer deposits. These shifting means proliferated and the French colonial authorities in Canada, for example, used payment cards signed by the Governor as a promise of payment since 1685, because sending money from France was very slow. It grew popular throughout the eighteenth century, but it still was lending money that was broadcast backed by gold or silver deposits. Trust money usually arose as an emergency measure during war times, such as the American greenback.
In the later years of the nineteenth century the need for international trade led to the creation of a gold standard in which all currencies could be exchanged for gold and the value of money (more than prices) was fixed by the parity of the currency to gold . Almost every government suspended the convertibility of their currencies during the First World War.
Money as we know it today (notes and coins without their own value) must be endorsed or certified by the issuing institution. Currently it is the governments, through laws, who determine which one is the kind of money of legal tender, but other entities are, such as central banks (Central Bank) and the mints, are responsible, first, to regulate and control monetary policy in an economy, and second, to create notes and coins on demand and the need for physical money.
Evolution of the backing of paper money to the present:
In the eighteenth and nineteenth centuries, many countries had a pattern based in two metals, gold and silver.
In 1821 the Bank of England was willing to repay in cash all notes that may be presented for payment; and would do so in gold. From that date on, gold was a monetary standard.
Between 1870 and the First World War the Gold Standard was mainly adopted, so that any citizen could convert the paper money in an equivalent amount of gold.
In the period between wars Governments tried to return to the Gold Standard, although the economic situation and the crisis or the crack of 1.929 ended with the convertibility of notes into gold for individuals.
At the end of the Second World War, the allies established a new financial system at the Bretton Woods agreements, where it was established that all the currencies would be converted into US dollars and only the US dollar would be convertible in gold bars at 35 dollars per ounce for foreign governments.
In 1971, expansionary financial policies in the USA, primarily motivated by spending in the Vietnam war , led to the abundance of dollars, raising doubts about its convertibility into gold. This made the European central banks to try to convert their dollar reserves into gold, creating an unsustainable situation for the USA. In response, in December 1971, USA President, Richard Nixon, unilaterally suspended the dollar's convertibility into gold for the citizens and devalued the dollar by a 10%. In 1973, dollar became devalued another 10%, until, finally, the convertibility into gold ended for governments and foreign central banks.
From 1973 until today, the money we use nowadays has a value that is in the subjective belief, that it will be accepted by the other inhabitants of a country or economic zone as a means of exchange. The monetary authorities and central banks do not intend to defend any particular level of the exchange rate, but they intervene in currency markets to smooth out short-term speculative fluctuations, in order to maintain short-term price stability, and avoid situations like hyperinflation, which makes the value of that money destroyed, because of the fading of confidence in it, or deflation.