Money is any good or token that functions as a medium of exchange that is socially and legally accepted in payment for goods and services and in settlement of debts. Money also serves as a standard of value for measuring the relative worth of different goods and services. Some authors explicitly require money to be a standard of deferred payment. Money is one of the most central topics studied in economics and forms its most cogent link to finance.
In common usage, money refers more specifically to currency, particularly the many circulating currencies with legal tender status conferred by a national state; deposit accounts denominated in such currencies are also considered part of the money supply, although these characteristics are historically comparatively recent. Money may also serve as a means of rationing access to scarce resources and as a quantitative measure that provides a common standard for the comparison and valuation of quality as well as quantity, such as in the valuation of real estate or artistic works.
The use of money provides an easier alternative to barter, which is considered in a modern, complex 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 transaction can occur. The efficiency gains through the use of money are thought to encourage trade and the division of labour, in turn increasing productivity and wealth.
Early commodity systems
A number of commodity money systems were amongst the earliest forms of money to emerge. For example
* the shekel referred to a specific volume of barley in ancient Babylon * iron sticks were used in Argos.
* cowries were used as a money in Africa , ancient China and throughout the South Pacific.
* salt was used as a currency in Europe. * ox-shaped ingots of copper seem to have functioned as a currency.
* state certified weights of gold and silver functioned as currency and gave rise to the development of coinage
* rum-currency operated in the early European settlement of Sydney cove in Australia.
* cash crops such as tobacco, rice, wheat, indigo, and maize were used as money.
Under a commodity money system, the objects used as money have intrinsic value, i.e., they have value beyond their use as money. For example, gold coins retain value because of gold’s useful physical properties besides its value due to monetary usage, whereas paper notes are only worth as much as the monetary value assigned to them. Commodity money is usually adopted to simplify transactions in a barter economy, and so it functions first as a medium of exchange. It quickly begins functioning as a store of value, since holders of perishable goods can easily convert them into durable money.
Coins are commonly used for the smaller denominations of a country’s currency system.The larger denominations of currency in both regions consist of paper money throughout the world.
The rise of fiat currencies
The bulkiness and limited transportability of some forms of commodity money. This led to the invention of symbolic substitutes for commodity money. The goldsmiths were the precursors of leading banks in England and the receipts they issued were the precursors of the banknote. During the 19th Century commercial banks in Europe and North America issued their own banknotes based on the same principle of partial backing.
By the end of the 19th century, however, most countries prohibited private issues of banknotes or brought private issuers under the control of central banks.
Banknotes (also known as paper money) and coins are the most liquid forms of symbolic money and are commonly used for small person-to-person transactions. Cheques, debit cards and wire transfers are used as means to more easily transfer larger amounts of money between bank accounts. Electronic money is an entirely non-physical currency that is traded and used over the internet.
The invention of symbolic substitutes for money further loosened the association between money and barter and opened the way for fiat money. Fiat money is currency that has negligible inherent value and is not backed by any commodity. A central authority (government) creates a new money object by issuing paper currency or creating new bank deposits. The widespread acceptance of fiat money is most frequently enhanced by the central authority mandating the money’s acceptance as legal tender and demanding this money in payment of taxes or tribute.
By the early 1970s almost all countries had abandoned the gold standard and converted their national currencies to pure fiat money. Today, gold is commonly used as a store of value, but is not often used as a medium of exchange or a unit of account. But central banks do use gold as a unit of account.
Today’s national currencies are backed by the governments that issue them, not by gold or silver, and the governments are backed by the productive capacity of the societies they represent.
In 1999, a number of countries in the European Union adopted a common currency, the euro.
In addition, a number of countries including Ecuador and El Salvador have adopted the policy of dollarization, abandoning the national currency in favor of that of another country, most commonly the United States dollar.
Economic analysis of currency unions focuses on two issues. The theory of optimum currency areas deals with the extent to which countries or regions experience common economic shocks and can therefore benefit from a common monetary policy. Countries with high levels of trade and similar economic structures may benefit from a currency union. The literature on central bank credibility deals with the conditions under which central banks can make a credible commitment to avoid inflation. When these conditions are not met, dollarization may be an appropriate policy response.
Major world currencies
* Australia – Australian Dollar (AUD) * Canada – Canadian Dollar (CAD) * European Monetary Union – Euro (EUR)
* Hong Kong – Hong Kong Dollar (HKD) * Japan – Japanese Yen (JPY) * Switzerland – Swiss Franc (CHF)
* United Kingdom – Pound Sterling (GBP) * United States – US Dollar (USD)
Besides these currencies gold and silver are traded globally on the currency markets:
* Gold (XAU) quoted in 1 ounce increments
* Silver (XAG) quoted in 1000 ounce increments
In addition, the Chinese Renminbi is an important currency in international trade, but trade in financial markets is subject to central bank restrictions.
Social and political impact of money
The evolution of money illustrates how each new social institution creates linkages with other existing social institutions as it develops and those linkages gradually expand into complex networks of relationships until they become inseparable elements of a single social web. The evolution of money began as a medium and ended as a force for restructuring political and social relationships.
Over time, money has helped breakdown the rigid class structure which allocated privileges according to one’s birth. In a money economy access to goods and services is based on the capacity to pay rather than one’s social origins. Thus it helps eliminate social discrimination based on caste and class.
As a medium for storage of value, it gave rise to banking. Banks pooled economic resources, and provided a legal structure for transporting money over great distances. This in turn allowed the development of capital intensive trade routes around the globe. At a later date, pooled capital permitted large scale investments in productive capacity and infrastructure, thus facilitating the industrial revolution.
Money has also changed political and social structure. The ever increasing need of that government for more funds created the need for taxation and made governments increasingly dependent and subject to those sections of society that possessed or controlled large sums of money. The right to collect taxes initially helped monarchy centralize power and influence in a national government.
Money has also played an important role in population migrations and the shifting balance of power between individuals, the state and religious institutions.
The need for large sums of money helped limit the power of absolute monarchs and caused the realignment of social roles. Despite their philosophical and religious claims, to absolute power the monarchs of the middle ages were frequently dependent on wealthy bankers and traders for the funds to wage war. This forced a limited form of power sharing and rule by consensus.
Money is generally considered to have the following characteristics, which are summed up in a rhyme: “Money is a matter of functions four, a medium, a measure, a standard, a store.”
Types of money
Importance of distinguishing between three types of money: commodity money, fiat money, and credit money.
Commodity money is any money that is both used as a general purpose medium of exchange and as a tradable commodity in its own right.
Commodity based currencies are often viewed as more stable, but this is not always the case. The value of a commodity based currency as a medium of exchange depends on its supply relative to other goods and services available in the economy.
Historically, gold, silver and other metals commonly used in commodity based monetary systems have been subject to regular and sometimes extraordinary fluctuations in purchasing power. This not only damages its stability as a medium of exchange; it also reduces its effectiveness as a store of value.The advantage of gold and silver, however, lies in the fact that, unlike fiat paper currency, the supply cannot be increased arbitrarily by a central bank.
It is also possible for the trading value of a commodity money to be greater than its value as a medium of exchange. When this happens people will often start melting down coins and reselling the metal used to make them.
Commodity money’s ability to function as a store of value is also limited by its very nature. Copper and tin risk rust and corrosion. Gold and silver are soft metals that can lose weight through scratches and abrasions.
Commodity based currencies also limit the geographic extent of the trading market. To make large purchases either a large volume or a high weight or both of the commodity must be transported to the seller. The cost of transportation of the currency raises the transaction cost and makes long distance sales less attractive.
Fiat money is any money whose value is determined by legal means rather than the relative availability of goods and services. Fiat money may be symbolic of a commodity or government promises.
Fiat money provides solutions to several limitations of commodity money. It can be printed without limit, so there is no limit on trade volumes.
Fiat money, especially in the form of paper or coins, can be easily damaged or destroyed. However, it has has an advantage over commodity money in that the same laws that created the money can also define rules for its replacement in case of damage or destruction. By contrast commodity money is gone for good.
Paper money is especially vulnerable to everyday hazards: from fire, water, termites, and simple wear and tear. In order to reduce replacement costs, many countries are converting to plastic bills.
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 counterfeiters are allowed to flourish.
Perhaps the biggest criticism of paper money relates to the fact that its stability is highly dependent on the stability of the legal system backing the currency. Should the legal system fail, so would the currency that depends on it.
Credit money is any claim against a physical or legal person that can be used for the purchase of goods and services. Credit money differs from commodity and fiat money in two important ways: It is not payable on demand 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
The money supply is the amount of money available within a specific economy available for purchasing goods or services.
Monetary policy is the process by which a government, central bank, or monetary authority manages the money supply to achieve specific goals. Usually the goal of monetary policy is to accommodate economic growth in an environment of stable prices. “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”
A failed monetary policy can have significant detrimental effects on an economy and the society that depends on it. These include hyperinflation, stagflation, recession, high unemployment, shortages on imported goods, inability to export goods, and even total monetary collapse and the adoption of a much less efficient barter economy.
Quotations on money
* “No one can serve two masters, for either he will hate the one and love the other; or else he will be devoted to one and despise the other. You can’t serve both God and Mammon.” Gospel of Matthew
* “When it’s a question of money, everybody is of the same religion.” Voltaire
* “When I have money, I get rid of it quickly, lest it find a way into my heart.” John Wesley
* “Money. It’s a gas.” Pink Floyd
* “Everybody loves money. That’s why it’s called ‘money’.” Danny DeVito
* “Money doesn’t talk, it swears.” Bob Dylan
* “If you want to know what a man is really like, take notice of how he acts when he loses money.” New England Proverb
* “Money is worthless unless some people have it and others do not”