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AP US History Different types of Money Money is the lubricant that greases the wheels of the economy. This is how: 1. Money is a medium of exchange with a uniform agreed-­‐upon value. Money’s use speeds up transactions and increases the variety of possible transactions because nobody has to compute how many chickens a pig is worth; they just sell a pig for X dollars and then buy a chicken for Y dollars. 2. Another advantage of money is that it keeps its value if you put it in storage and ignore it, which is also something that does not work well with chickens and pigs. 3. Yet another advantage of money is that it serves not only as a uniform measure of value, but also as a uniform measure of debt. This enables the widespread lending of capital among people who do not even know each other, further promoting economic activity. Banks are often crucial to facilitating this role of money in an economy, central clearinghouses that take excess capital and put it to use. Traditionally, money was some kind of metal, often gold or silver, with a value everyone agreed upon. But by 1800, the amount and value of commerce outpaced the growth of any precious metal reserves. Americans came up with other media of exchange as their needs arose. All kinds of money, or currency, circulated simultaneously. US and foreign Hard Money mingled with Specie Money issued by various state banks, Bills of Exchange used to facilitate foreign trade, and Bank Notes, or Credit Money, used both internationally and domestically. Here are the classifications: •
HARD MONEY, “The coin of the Realm” – This type of currency is made of precious metals that hold value across time and civilizations, the exchange value being determined by the relative weight and purity of the metal. In the 21st century, the face value of a coin is most often higher than its value as a metal, thus modern coinage operates more as Fiat Money (see below). •
SPECIE MONEY – An adaptation of Hard Money designed for commerce, where a Paper Note holds value because it is backed by a reserve of precious metal, either in a bank vault or national treasury. •
CREDIT MONEY – Currency that is backed only by a collective belief in the stability of its issuer. If issued by a government or chartered bank in the form of Bank Notes, it was generally supposed to be redeemable for Specie Money upon demand. Credit money was also issued by private banks, often backed by land holdings with a market value theoretically greater than the total of the Bank Notes issued. Large businesses also sometimes issued credit money. As credit money was not actually backed by Hard Money or Specie Money, a panic (too many people wanting to exchange their notes for specie at the same time) would often cause the collapse of the issuing bank. Credit money is worth no more than the popular faith in the institution that issues it. It is just that faith that prevents panics. Since 1933, panics have been averted and faith in U.S. banks has been supported by the FDIC, a federal program that insures individual deposits, up to a set value, against bank failure. •
FIAT MONEY – A particular type of Credit Money, it holds particular value because the government accepts or requires it as payment for taxes, and the government has a reasonable expectation of being able to collect those taxes. It is not backed by any precious metal. Much of the money in circulation today is fiat money because it is only used by mutual agreement (fiat) that it will serve as a medium of exchange. Today the dollar’s value is supported by faith in the size of the economy. The reason exchange rates with other countries’ currencies fluctuate so much is that our dollar’s market value is determined by the international demand for dollars or dollar-­‐denominated investments on any given day. Cause of inflation in the 19th century A general rule for both Credit Money and Fiat Money is that if more of it is introduced into the economy – either printed or loaned out – than the institution can reasonably expect to have flowing back in – either through returns on investments (Bank Notes) or payments of taxes (Fiat Money) – the value of the currency goes down relative to its exchange rate or purchasing power. As with any increase in the money supply that is not backed by real value, this results in a rise in prices – inflation.