What is Commodity Money?

Commodity money is a form of money that has an intrinsic value, meaning it is worth something in its own right rather than simply being a token of financial value such as a banknote. The best known form is gold or silver coins, though any commodity can fulfill this role.

Most types of cash used today do not have any real intrinsic value. For example, a banknote is virtually worthless in itself and only has value because society accepts it as a measure of currency and a unit of exchange. This type of currency is known as fiat money.

Historically, other forms of money were used that did have an underlying value, such as foods, fuels, or metals. Such commodities are not widely used in modern economies as their underlying value can vary immensely from their agreed currency value. There is also the problem that many of these items are prone to spoiling or deteriorating.

Some forms of commodity money may only fulfill the money role in very specific circumstances. Perhaps the best known example is the use of cigarettes as currency in prisons. With no cash available to prisoners, cigarettes can serve as a medium of exchange that avoids the need to rely on bartering for direct exchange of items. Cigarettes also have intrinsic value, as they can be smoked.

Something that serves as commodity money only has to have value in itself, rather than being of use to the bearer. For example, there is little most people can actually do with a gold coin and, if someone is a smoker, a cigarette is of more practical use. The gold coin has a much higher value, though, as a jeweler or goldsmith would be able to make use of it to produce an expensive object.

Where metal coins are used as an officially recognized currency, the government will set a fixed value for each type of coin. It is this value that prevails in the economy, rather than the actual worth of the metal in each coin. Usually, the coin's face value will be more than the actual costs of the component metals. In a few rare situations, the combination of inflation devaluing currency and metal prices rising, a coin may be worth more as a metal than a unit of currency. If this persists, the government may decide to withdraw that unit of currency from circulation.