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Money
Money is anything that is generally accepted in payment for goods and services and in
repayment of debts.[1] The main uses of money are as a medium of exchange, a unit of
account, and a store of value.[2] Some authors explicitly require money to be a standard of
deferred payment.[3]
Money includes both currency, particularly the many circulating currencies with legal
tender status, and various forms of financial deposit accounts, such as demand deposits,
savings accounts, and certificates of deposit. In modern economies, currency is the
smallest component of the money supply.
Money is not the same as real value, the latter being the basic element in economics.
Money is central to the study of economics and forms its most cogent link to finance. The
absence of money causes a market economy to be inefficient because it requires a
coincidence of wants between traders, and an agreement that these needs are of equal
value, before a barter exchange can occur. The use of money is thought to encourage
trade and the division of labour.
Contents
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1 Economic characteristics
o 1.1 Medium of exchange
o 1.2 Unit of account
o 1.3 Store of value
2 Market liquidity
3 Types of money
o 3.1 Commodity money
o 3.2 Representative money
o 3.3 Credit money
o 3.4 Fiat money
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3.5 Money supply
3.6 Monetary policy
4 History of money
5 See also
6 References
7 External links
Economic characteristics
Money is generally considered to have the following characteristics, which are summed
up in a rhyme found in older economics textbooks and a primer: "Money is a matter of
functions four, a medium, a measure, a standard, a store." That is, money functions as a
medium of exchange, a unit of account, and a store of value.[2][4][5]
There have been many historical arguments regarding the combination of money's
functions, some arguing that they need more separation and that a single unit is
insufficient to deal with them all. One of these arguments is that the role of money as a
medium of exchange is in conflict with its role as a store of value: its role as a store of
value requires holding it without spending, whereas its role as a medium of exchange
requires it to circulate.[5] 'Financial capital' is a more general and inclusive term for all
liquid instruments, whether or not they are a uniformly recognized tender.
Medium of exchange
Main article: Medium of exchange
Money is used as an intermediary for trade, in order to avoid the inefficiencies of a barter
system, which are sometimes referred to as the 'double coincidence of wants problem'.
Such usage is termed a medium of exchange.
Unit of account
Main article: Unit of account
A unit of account is a standard numerical unit of measurement of the market value of
goods, services, and other transactions. Also known as a "measure" or "standard" of
relative worth and deferred payment, a unit of account is a necessary prerequisite for the
formulation of commercial agreements that involve debt.
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Divisible into small units without destroying its value; precious metals can be
coined from bars, or melted down into bars again.
Fungible: that is, one unit or piece must be perceived as equivalent to any other,
which is why diamonds, works of art or real estate are not suitable as money.
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A specific weight, or measure, or size to be verifiably countable. For instance,
coins are often made with ridges around the edges, so that any removal of
material from the coin (lowering its commodity value) will be easy to detect.
Store of value
Main article: Store of value
To act as a store of value, a commodity, a form of money, or financial capital must be
able to be reliably saved, stored, and retrieved — and be predictably useful when it is so
retrieved. Fiat currency like paper or electronic currency no longer backed by gold in
most countries is not considered by some economists to be a store of value.
Market liquidity
Main article: Market liquidity
Liquidity describes how easily an item can be traded for another item, or into the
common currency within an economy. Money is the most liquid asset because it is
universally recognised and accepted as the common currency. In this way, money gives
consumers the freedom to trade goods and services easily without having to barter.
Liquid financial instruments are easily tradable and have low transaction costs. There
should be no — or minimal — spread between the prices to buy and sell the instrument
being used as money.
Types of money
In economics, money is a broad term that refers to any instrument that can be used in the
resolution of debt. However, different types of money have different economic strengths
and liabilities. Theoretician Ludwig von Mises made that point in his book The Theory of
Money and Credit, and he argued for the importance of distinguishing among three types
of money: commodity money, fiat money, and credit money. Modern monetary theory
also distinguishes among different types of money, using a categorization system that
focuses on the liquidity of money.
Commodity money
Main article: Commodity money
Commodity money is any money whose value comes from the commodity out of which it
is made. The commodity itself constitutes the money, and the money is the commodity.[6]
Examples of commodities that have been used as mediums of exchange include gold,
silver, copper, salt, peppercorns, large stones, decorated belts, shells, alcohol, cigarettes,
cannabis, and candy. Since payment by commodity generally provides a useful good,
commodity money is similar to barter, but is distinct because commodity money uses a
single recognized unit of exchange.
Representative money
Main article: Representative money
Representative money is money that consists of token coins, other physical tokens such
as certificates, and even non-physical "digital certificates" (authenticated digital
transactions) that can be reliably exchanged for a fixed quantity of a commodity such as
gold, silver or potentially water, oil or food. Representative money thus stands in direct
and fixed relation to the commodity which backs it, while not itself being composed of
that commodity.
Banknotes from all around the world donated by visitors to the British Museum, London.
Credit money
Main article: Credit money
Credit money is any claim against a physical or legal person that can be used for the
purchase of goods and services.[6] Credit money differs from commodity and fiat money
in two ways: It is not payable on demand (although in the case of fiat money, "demand
payment" is a purely symbolic act since all that can be demanded is other types of fiat
currency) and there is some element of risk that the real value upon fulfillment of the
claim will not be equal to real value expected at the time of purchase.[6]
This risk comes about in two ways and affects both buyer and seller.
First it is a claim and the claimant may default (not pay). High levels of default have
destructive supply side effects. If manufacturers and service providers do not receive
payment for the goods they produce, they will not have the resources to buy the labor and
materials needed to produce new goods and services. This reduces supply, increases
prices and raises unemployment, possibly triggering a period of stagflation. In extreme
cases, widespread defaults can cause a lack of confidence in lending institutions and lead
to economic depression. For example, abuse of credit arrangements is considered one of
the significant causes of the Great Depression of the 1930s.[7]
The second source of risk is time. Credit money is a promise of future payment. If the
interest rate on the claim fails to compensate for the combined impact of the inflation (or
deflation) rate and the time value of money, the seller will receive less real value than
anticipated. If the interest rate on the claim overcompensates, the buyer will pay more
than expected.
Over the last two centuries, credit money has steadily risen as the main source of money
creation, progressively replacing first commodity and then representative money. In
many cases credit money has been converted to fiat money (see below), as governments
have backed certain private credit instruments (first banknotes from central banks, then
later certain types of deposits to banks), thus converting central banknotes to legal tender,
and other types of notes (deposit certificates of less than a certain value) to a status not
very different from fiat money, since they are backed by the power of the central
government to redeem eventually with tax collection.
A particular problem with credit money is that its supply moves in line with the business
cycle. When lenders are optimistic, notably when the debt level is low, they increase their
lending activity which creates new money. This may also trigger inflation and bull
markets. When creditors are pessimistic (for instance, when debt level is perceived as too
high, or unwise lending activity in the past has resulted in situations where defaults are
expected to follow), then creditors reduce their lending activity and money becomes
"tight" or "illiquid." Bear markets, characterized by bankruptcies and market recessions,
then follow.
Fiat money
Main article: Fiat money
Fiat money is any money whose value is determined by legal means, rather than the
strict availability of goods and services which are named on the representative note.
Fiat money is created when a type of credit money (typically notes from a central bank,
such as the Federal Reserve System in the U.S.) is declared by a government act (fiat) to
be acceptable and officially-recognized payment for all debts, both public and private.
Fiat money may thus be symbolic of a commodity or a government promise, though not a
completely specified amount of either of these. Fiat money is thus not technically fungible
or tradable directly for fixed quantities of anything, except more of the same
government's fiat money. Fiat moneys usually trade against each other in value in an
international market, as with other goods. An exception to this is when currencies are
locked to each other, as explained below. Many but not all fiat moneys are accepted on
the international market as having value. Those that are trade indirectly against any
internationally available goods and services [6]. Thus the number of U.S. dollars or
Japanese yen which are equivalent to each other, or to a gram of gold metal, are all
market decisions which change from moment to moment on a daily basis. Occasionally, a
country will peg the value of its fiat money to that of the fiat money of a larger economy:
for example the Belize dollar trades in fixed proportion (at 2:1) to the U.S. dollar, so
there is no floating value ratio of the two currencies.
Representative, credit, and fiat money all provide solutions to several limitations of
commodity money. Depending on the laws, there may be little or no need to physically
transport the money — an electronic exchange may be sufficient. Other types of moneys
have as their sole use to be medium of exchange, so their supply is not limited by
competing alternate uses. Credit and fiat monies can be created without limit in theory, so
there is no limit on trade volumes.
Fiat money, if physically represented in the form of currency (paper or coins) can be
easily damaged or destroyed. However, here fiat money has an advantage over
representative or commodity money, in that the same laws that created the money can
also define rules for its replacement in case of damage or destruction. For example, the
U.S. government will replace mutilated federal reserve notes (U.S. fiat money) if at least
half of the physical note can be reconstructed, or if it can be otherwise proven to have
been destroyed. [8]. By contrast, commodity money which has been destroyed or lost is
gone.
Paper currency is especially vulnerable to everyday hazards: from fire, water, termites,
and simple wear and tear. Currency in the form of minted coins is more durable but a
significant portion is simply lost in everyday use. In order to reduce replacement costs,
many countries are converting to plastic currency. For example, Mexico has changed its
twenty and fifty peso notes, Singapore its $2, $5, $10 and $50 bills, Malaysia with RM5
bill, and Australia and New Zealand their $5, $10, $20, $50 and $100 to plastic, both for
the increased durability and because plastic may be easily specifically constructed for
each denomination, thus making it impossible for counterfeiters to "lift" or raise the value
of a bill by using the material of a bill of lesser value as a primary source to make a
counterfeit note of higher value.
Some of the benefits of fiat money can be a double-edged sword. For example, if the
amount of money in active circulation outstrips the available goods and services for sale,
the effect can be inflationary. This can easily happen if governments print money without
attention to the level of economic activity, or if successful counterfeiters flourish.
A criticism of credit and fiat moneys relates to the fact that their stabilities are highly
dependent on the stability of the legal system backing the currency: should the legal
system fail, so will the value