The Commodity Theory of Money

Last Updated on August 27, 2024

The commodity theory of money is the view that money emerged from barter and that physical commodities that were well suited as a store of value and a medium of exchange came to function as money.

This theory is asserted by the Austrian School of economics. The founder Carl B. Menger stated:

“[Money] is not the product of a legislative act. Even the sanction of political authority is not necessary for its existence. Certain commodities came to be money quite naturally, as the result of economic relationships that were independent of the power of the state.”

The type of commodity used varied based on place and time. Some prominent commodities used as money were cattle, cowrie shells, feathers, beads, and beans.

Over time the commodity most suited to the function of money came to dominate.

First this was the precious metals gold and silver, and eventually just gold alone.

It is important to understand the theories of money because we are currently on the cusp of a monetary revolution.

Fiat money is losing credibility. Interest in gold is re-emerging and the rise of Bitcoin is forcing many people to ask some serious questions about the nature of money and the type of society and economy we want to live in.

Asking the question “what is money?” is an important intellectual and practical task.

Commodity Theory vs Claim Theory vs Fiat Theory

Ludwig von Mises identifies three types of money:

“We may give the name commodity money to that sort of money that is at the same time a commercial commodity; and the name fiat money to money that comprises things with a special legal qualification. A third category may be called credit money, this being that sort of money which constitutes a claim against any physical or legal person.”

The main competing theory to the commodity theory of money is the credit theory or claim theory.

It is the idea that money is essentially a claim or credit against some tangible asset or the ability to receive goods and services in the future.

Geoffrey Ingham makes the case:

“Money is a social relation of credit and debt denominated in a money of account. In the most basic sense, the possessor of money is owed goods. But money also represents a claim or credit against the issuer – monarch, state, bank and so on. Money has to be ‘issued’. And something can only be issued as money, if it is capable of cancelling any debt incurred by the issuer…Money cannot be said to exist without the simultaneous existence of a debt that it can discharge.”

Mises puts it more simply:

“Credit money…is a claim falling due in the future that is used as a general medium of exchange.”

The fiat theory simply suggests that money has value because the state says so, through a declaration of legal tender.

As Mises says:

“Here the deciding factor is the stamp, and it is not the material bearing the stamp that constitutes the money, but the stamp itself. The nature of the material that bears the stamp is a matter of quite minor importance.”

The Characteristics of Money According To The Commodity Theory

To be well suited as money a commodity needs to fulfil the following functions as well as possible:

• Scarcity: The commodity needs to be sufficiently scarce so that the supply does not change rapidly.
• Durability: The commodity needs to maintain its physical characteristics across time. It cannot rust, rot, burn, explode etc.
• Portability: The commodity needs to be able to be transported relatively easily across distance.
• Divisibility: The commodity can be easily sub-divided into smaller units.
• Fungibility: Each individual unit of the commodity should not differ from one another, so that one unit has the same value as every other unit.

Some argue that the commodity should also have some utility. That means it has some use other than money, normally either as food or as jewellery or some other aesthetic value.

Others argue that a commodity can still have value purely as a monetary good regardless of any other utility and in fact that monetary commodities obtain their value from their ability to be used as money not because of their secondary utility.

For thousands of years, gold and silver coexisted as the best forms of commodity money.

Gold was superior and held more value per unit due to its scarcity. But it was not that easily divisible and better used for large high value transactions. Therefore, silver found a niche as a lower value and more easily divisible money primarily suited for the day to day transactions of the masses.

In the 18th and 19th centuries silver was superseded by gold almost entirely as the world moved onto the gold standard with a single metal commodity becoming the monetary standard for most of the world.

Is Bitcoin A Commodity?

Where Bitcoin sits in the commodity theory of money is something that has been debated during the early years of its existence.

Bitcoin is a commodity in the sense that no one issues it or controls it. But many have argued that it is something different because it has no physical nature, no “backing” and no utility value other than money.

Rather than a physical commodity that you can hold in your hand, Bitcoin is actually a ledger that records who owns what. When you make a transaction, virtual coins do not zoom from one address to the other. Instead the ledger is updated to note a change in ownership between addresses.

I think that saying that Bitcoin is not a commodity because it is not physical is a mistake.

Often those who argue that Bitcoin cannot be a commodity argue that it has no “intrinsic value.”

But intrinsic value has been rejected by the Austrian School of Economics who state that value is obtained subjectively by the marketplace alone.

I agree with Konrad Graf who stated way back in 2014 that commodity money can be separated into two categories – material and digital – and therefore that Bitcoin is a commodity:

“Historical commodity monies and bitcoin, despite their large and apparent technical distinctions of implementation and production, are from this standpoint much more akin to one another than they might at first appear. The simplest solution for theoretical classification may be to take the existing category of commodity money, divide it into material and digital subtypes, and proceed from there with additional differentiations depending on which variable characteristics are to be addressed. Whatever the balance of historical investigation suggests was the case with monies at various times and places in the past, bitcoin is actually today a “pure” global commodity money, an unmediated monetary good.”

Michael Saylor believes Bitcoin to be a commodity and goes as far as calling it the apex commodity as well as the apex property, apex technology and apex money.

The United States Securities and Exchange Commission have also defined Bitcoin as a commodity.

So it seems pretty settled to me that Bitcoin is the latest addition to the commodity theory of money. It’s still a commodity, albeit a digital one, and it has now superseded gold as the commodity best suited to money.

Conclusion

The commodity theory of money as stated by the Austrian School of Economics argues that money emerges in society as a means to store and exchange value and that the commodity best suited to the task will be freely adopted by the market.

Historically, a large number of commodities have been used as money. As civilization developed and became more complex and higher quality monetary commodities like gold and silver became available, these became the monetary standard.

Now with the invention of the internet and Bitcoin, society has access to a purpose built digital commodity with superior sound money characteristics.

Sources

Mises, Ludwig von. Theory of Money & Credit. Indianapolis, Liberty Fund, 2019.