What is Commodity Money?

November 17, 20238 min read
What is Commodity Money?
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Key Highlights

  • Commodity money refers to a physical item such as gold or silver, that possesses intrinsic value, whereby its value transcends means of exchange.
  • Because it is no longer backed by gold, the U.S. dollar has no intrinsic value, which can make it more vulnerable than commodity money during economic turmoil.
  • Commodity money has been used throughout history and is still in use in certain circumstances.

Commodity money’s primary value is in its intrinsic value. This form of money consists of physical items that have a value or utility other than as a form of exchange medium.

Commodity money was thought to be first used in ancient days when trade, exchange, and economic activity in general were less sophisticated. People would use various goods to buy things and even to satisfy obligations. In that way, the practice of bartering introduced commodity money, in which specific items are given value. That evolved into today’s currency systems.

Historically, examples of commodity money include gold, silver, tea, alcohol, and seashells. Even if no one would accept such goods as trade, the owners could still use them for their purposes.

At length, though, commodity money became unfeasible largely due to issues with perishability, indivisibility, and heterogeneity. For example, because many items could not be kept for a long time, people were unable to repay loans or save them for future needs.

The following explores commodity money and its importance in investing, business, and finance.

What is Commodity Money?

Commodity money has worth independent of its use as money. By contrast, other forms of money, such as U.S. currency, get their value solely from the trust placed in it.

For example, while gold was used thousands of years ago as a common form of money, the precious metal was also used to craft jewelry. Thus, it had value beyond its use as an exchange medium. Other historic examples of commodity money include alcohol, tobacco, salt, cocoa beans, and soybeans.

During periods of economic upheaval, such as hyperinflation or severe depression, investors have been known to prioritize commodity money over the money their governments authorize. Commodity money is also more likely to experience deflation – a drop in general price levels, including those of assets. Deflation hedges often include cash, dividend-paying stocks, and cash.

What are the Characteristics of Commodity Money?

The major features of commodity money include:

  • Measurability. Money must be measured so that people can assess how much they are willing to pay. If the sole note in circulation was a $100 note, for example, it would likely be very difficult to purchase items that cost a dollar or two.
  • Durability. The commodity’s intrinsic value must be retained for trust in it to endure. For example, iron rusts easily, so it would not work as a commodity. Neither would meat since it spoils over time.
  • Exchangeability. Commodities that have historically caught on are convenient and easily traded. It is obviously easier and more inconvenient to take gold coins to market instead of, say, cows.
  • Rarity. Commodity money must be rare in that the supply is limited. Otherwise, unlimited amounts of money would result in massive inflation levels. Still, the commodity supply must be able to respond to heightening demand when stability returns.

Why is Commodity Money Valuable?

Money’s value is solely determined by the utility attributed to it by community or society consensus, while commodity money has underlying value. However, commodity money does risk widespread price fluctuations due to commodity price changes. For example, the discovery of a large cache of silver could result in a steep drop in the value of silver currency.

How Was Commodity Money Historically Used?

While it is virtually impossible to determine the genesis of commodity money, some records point to the period 700-500BC when electrum, an alloy of gold and silver, became a common form of money. Other evidence exists that dates commodity currencies back to ancient Egypt and Mesopotamia.

After World War II, gasoline and cigarettes were used as a form of commodity money in portions of Europe, including Belgium, France, and Germany.

Anthropologists and historians widely contend that commodity money evolved from a bartering system wherein participants accepted a common medium of exchange to enable transactions of goods and services.

Such a system was in place in 1630, when the Puritans first arrived on Massachusetts Bay. This markedly restricted trade, since two people seeking to do business had to possess equivalent parcels the other person desired and with which each person was willing to part.

To remedy the situation, the Massachusetts Bay General Court established standard prices for certain farm products and foodstuffs and passed a law that set limits on the price of farthings. Such products came to be called “country pay” and were ascribed specific rates so they could be used for tax payments.

A chief issue with commodity money was quality. People tended to utilize or sell their best products while offering their poorest goods as commodity money. Even some commodities of good quality would deteriorate if kept too long.

Another problem was transportation costs. Satisfying tax bills with barrels and bushels of produce required bringing the commodities to the colony treasury, a practice that became unsustainable. At length, it was clear that while commodity money worked to some extent, it became an undesirable way to conduct commerce.

Commodity Money Today

Commodity money continues to sporadically be used as currency, mostly in war-riven regions experiencing insufficient supplies of common goods combined with a monetary collapse. This occurred during the Siege of Sarajevo in 1993 and as recently as last year in Russian-occupied Kherson.

And even today, central banks continue to hold gold as part of a diverse portfolio of assets that comprise their official reserves. Gold remains the ultimate commodity money.

Commodity Money vs. Fiat Money

Fiat money is a government-issued currency that is backed by the government, rather than a physical commodity with value on its own, such as gold or silver. Fiat money’s value derives from the issuing government’s stability as well as supply and demand – not from a commodity’s intrinsic worth.

Most major modern global currencies, including the U.S. dollar and euro, are fiat currencies. With fiat money, central banks have greater economic control because they can regulate how much money is printed.

A danger of fiat money, though, is that if too much is produced, it can result in hyperinflation. For example, in the early 2000s, Zimbabwe’s central bank began to print money at a rapid pace, in hopes of solving acute economic woes.

That caused hyperinflation, which drove prices upward across the board. The situation quickly deteriorated to the point where citizens had to carry bags of cash to market just for essentials. At one point, a single U.S. dollar was worth about some 8.31 billion Zimbabwean dollars.

Is Art Commodity Money?

While art has value, it is not a commodity in the sense that gold and silver are, for example. Art is not commodity money in today’s market.

However, investors can still get involved with art through alternative investments. In the last several years, fine art has become increasingly popular as an alternative way to mix up one’s investment portfolio.

Art and Alternative Investments

In addition to helping diversify investment holdings, art has the potential to protect against inflation and has produced returns averaging 7.6%, regardless of stock market fluctuations. In fact, over the last couple of decades, the art market has outperformed the S&P 500, with returns exceeding 360%.

Investor demand for art is growing as well. According to a 2018 Deloitte investor survey, 81% of respondents wished their wealth managers offered opportunities to invest in art – a 66% year-over-year increase. For example, the online alternative investment platform Yieldstreet has a fractional ownership program featuring works by mid-career, as well as blue-chip artists.

Industry experts and seasoned investors recommend a portfolio mix that is not wholly tied to stock market fluctuations. Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk.

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million. These people were more capable of weathering losses of that magnitude, should the investments underperform.

However, Yieldstreet has opened several carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments.

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

In Summary

The history of commodity money, its evolution, and how it relates to today’s currencies is important in investing, business, and finance. And while art is no longer used as commodity money, investors can still participate in the market through a fractional art program such as the one offered by Yieldstreet.

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