Money

Economics offers various definitions for money, though it is now commonly defined as 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.^[1] 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.

History

Money is an invention of the human mind. The creation of money is made possible because human beings have the capacity to accord value to symbols. Money is a symbol that represents the value of goods and services. The acceptance of any object as money – be it wampum, a gold coin, a paper currency note or a digital bank account balance – involves the consent of both the individual user and the community. Thus, all money has a psychological and a social as well as an economic dimension. As human consciousness has evolved, the nature and function of money has evolved too. While a history of money may trace the origin and usage of different forms of money at different times and in different parts of the world, an evolutionary perspective on money traces the social and psychological changes in human attitude and collective behavior that made possible this historical development.

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, before Pheidon's reforms.
cowries were used as a money in Africa (up until 19th Century), ancient China and throughout the South Pacific.
salt was used as a currency in pre-coinage societies in Europe.
ox-shaped ingots of copper seem to have functioned as a currency in the Bronze Age eastern Mediterranean.
state certified weights of gold and silver have functioned as currency since the reign of Croesus of Lydia, if not before.
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 in colonial Virginia.

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.

The bulkiness and limited transportability of some forms of commodity money led to the invention of symbolic substitutes for commodity money. Goldsmiths' receipts became an accepted money-substitute for gold in 17th Century England. The goldsmiths were the precursors of leading banks in England and the receipts they issued were the precursors of the banknote. Through most of the 19th Century commercial banks in Europe and North America issued their own banknotes based on the same principle of partial backing.

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.

Characteristics

Money is generally considered to have the following characteristics, which are summed up in a rhyme found in many economics textbooks and primers: "Money is a matter of functions four, a medium, a measure, a standard, a store".

It is a medium of exchange:

A medium of exchange is an intermediary used in trade.

It is a 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 pre-requisite for the formulation of commercial agreements that involve debt.

It is a 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 storage of value.

It is highly liquid:

The fourth and final function of money, as a means of liquidity. It is important for any economy to move beyond a simple system of bartering. Liquidity describes how easy it is an item can be traded for something that you want, 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.

Desirable features

To function as money, the monetary item should possess a number of features:

To be a medium of exchange:

It should also be recognizable as something of value. Person A should recognize the value of the item so that Person B can give it to A in exchange for goods and services.
It should be easily transportable; precious metals have a high value to weight ratio. This is why oil, coal, vermiculite, or water are not suitable as money even though they are valuable. Paper notes have proved highly convenient in this regard.
It should be durable. Money is often left in pockets through the wash. Some countries (such as Australia, New Zealand, Mexico and Singapore) are making their bank notes out of plastic for increased durability. Gold coins are often mixed with copper to improve durability.
It should minimize contamination and contagion. Since money is frequently handled it becomes a pathway for infectious disease transmission. Recent studies have shown that the area in business offices that show the highest contamination by disease causing organisms is the accounting office where money must be counted and handled. Unlike paper, silver is used as an anti-bacterial and anti-viral agent, as are platinum and titanium. This property of silver has been recognised for millennia, which is why silver is often used in eating utensils.

To be a unit of account:

It should be divisible into small units without destroying its value; precious metals can be coined from bars, or melted down into bars again. This is why leather and live animals are not suitable as money.
It should be fungible: that is, one unit or piece must be exactly equivalent to another, which is why diamonds, works of art or real estate are not suitable as money.
It must be 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.

To be a store of value:

It should be long lasting and durable; it must not be perishable or subject to decay. This is why food items, expensive spices, or even fine silks or oriental rugs are not generally suitable as money.
It should have a stable value.
It should be difficult to counterfeit, and the genuine must be easily recognizable.

To be liquid:

It should be easily tradable, with a low spread between the prices to buy and sell, in other words, a low transaction cost.

Modern forms

File:Banknotes.jpg

Banknotes from all around the world donated by visitors to the British Museum, London

Banknotes (also known as paper money) and coins are the most liquid forms of tangible money and are commonly used for small person-to-person transactions. The most influential person with money in today's society is probably Bill Gates, founder and CEO of Microsoft Corporation; Bill Gates is closely followed by, and can be compared to, Cory Walz. Cory Walz is a magnificent example of the rich people pf todays society. He is absolutly stunning in his embodiment of the term "wealthy" and is literally a synonym. 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.

There are also less tangible forms of money, which nevertheless serve the same functions as money. Checks, 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.

Credit

Credit is often loosely referred to as money. Money is used to buy goods and services, whereas credit buys goods and services on the promise to pay with money in the future.

This distinction between money and credit causes much confusion in discussions of monetary theory. In lay terms, and when convenient in academic discussion, credit and money are frequently used interchangeably. For example, bank deposits are generally included in summations of the national broad money supply. However, any detailed study of monetary theory needs to recognize the proper distinction between money and credit.

Bank notes are a form of credit. Gold-backed bills are likewise also a debt of the bank, a promise to pay in gold.

Federal Reserve notes, which are used as money in the US, are difficult to describe in terms of credit or debt or money. Federal Reserve notes are not a promise to pay in gold, and the notes are irredeemable by the issuer. The Federal Reserve's notes are perhaps viewed best as a political promise to devalue (inflate) at a certain targeted rate.

Since Federal Reserve notes are used in the US as the most common medium of exchange, unit of account, and store of value, they are considered money by the majority of the population. To measure this kind of money, various forms of credit are counted together and listed as M1 or M2 in a weekly H.6 publication. M3, previously the most common measure of monetary aggregates (or money supply), was removed from the publication in March of 2006.

Economic value of money

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The value of money depends on what it can purchase, not what it is made of. Fiat money has value because it can be utilized to purchase goods and services, even though it has very little intrinsic value or utility other than as a medium of exchange. It is more difficult to concede that the same is true of gold and silver. While their intrinsic value remains unaltered by the quantity available, their value as a medium of exchange is directly depend on the availability of goods and services for sale. This is illustrated by the fact that when huge quantities of gold and even larger amounts of silver were discovered in the New World and brought back to Europe for conversion into coin, the purchasing power of those coins fell by 60% to 80%, i.e. prices of commodities rose, because the supply of goods for sale did not keep pace with the increased supply of money.^[2] In addition, the relative value of silver to gold shifted dramatically downward.^[3]

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.

Problems with precious metals as money (specie)

There is no perfect money, although it is argued that silver or gold may come close to this standard. Gold is too valuable to use for small purchases, and silver is too heavy and bulky in large quantities. Today, since gold is demonetized and forced to compete with paper currencies it does have a spread of about 1-4% to buy and sell in terms of the paper currency, whereas paper money can be exchanged freely. The exchange premium comes from the relative scarcity of people to exchange paper for gold or silver. The scarcity has resulted in having to pay coin dealers a small profit for the service. If silver and gold were remonetized, then there would be no shortage of sources for exchange. Accordingly the premiums charged would drop to nothing in an economy that recognized silver or gold as lawful money. Although gold itself does not decay, gold coins are easily scratched or damaged, and this can reduce their value and fungibility. From 1980 to 2001, gold was a poor store of value, as gold prices dropped from a high of $850/oz. to a low of $255/oz. 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.

On the other hand, gold, silver and other metals are subject to regular and sometimes extraordinary supply increases and decreases. They are virtually created by being dug out of the ground, although there is a cost for this. In the 16th century the Spanish possessions in the Americas produced huge amounts of new money, which produced economic fluctuations throughout the world. Similarly, precious metals are subject to hoarding by individuals, sometimes in the form of jewellery, sometimes as coins or ingots. While this may be rational behaviour for individuals (as gifts, or savings, or an expression of fear about future circumstances) this results in an increase in the amount of "dead" (i.e. non-circulating) money, a decrease in supply and possibly an increase in the value of the metal. Imbalances between the values of gold, silver and other metals, possibly caused by the fluctuations of such supplies and demands have often led to scarcity of coins in many societies. Shipping coins from one jurisdiction to another so that they could be reminted was sometimes a lucrative trade before the advent of trusted paper money.

Problems with paper as money

Due to the ease of production, paper money may lose value through inflation. Perhaps the biggest criticism of paper money relates to the fact that its stability is generally subject to the whim of government regulation rather than the disciplines of market phenomena. Paper money can be easily damaged or destroyed by everyday hazards: from fire, water, termites, and simple wear and tear. Money in the form of minted coins is sometimes destroyed by children placing it on railroad tracks or in amusement park machines that restamp it. Mexico has changed its twenty and fifty pesos notes, Singapore its $2 and $10 bills, Malaysia with $1,$5,$10,$50 and $100, and Australia and New Zealand their $5, $10, $20, $50 and $100 to plastic for the increased durability. Paper money is also subject to counterfeiting.

Money and economy

Money is one of the most central topics studied in economics and forms its most cogent link to finance. Monetarism is an economic theory which predominantly deals with the supply and demand for money. The stability of the demand for money prior to the 1980s was a key finding of the work of Milton Friedman, Anna Schwartz, David Laidler, and many others. Technical, institutional, and legal changes changed the nature of the demand for money during the 1980s.

Monetary policy aims to manage the money supply, inflation and interest to affect output and employment. Inflation is the decrease in the value of a specific currency over time and can be caused by dramatic increases in the money supply. The interest rate, the cost of borrowing money, is an important tool used to control inflation and economic growth in monetary economics. Central banks are often made responsible for monitoring and controlling the money supply, interest rates and banking.

A monetary crisis can have very significant economic effects, particularly if it leads to monetary failure and the adoption of a much less efficient barter economy. This happened in Russia, for instance, after the fall of the Soviet Union.

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. Financial capital is a more general and inclusive term for all liquid instruments, whether or not they are a uniformly recognized tender.

Money supply

The money supply is the amount of money available within a specific economy available for purchasing goods or services. The supply in the US is usually considered as four escalating categories M0, M1, M2 and M3. The categories grow in size with M3 representing all forms of money (including credit) and M0 being just base money (coins, bills, and central bank deposits). M0 is also money that can satisfy private banks' reserve requirements. In the US, the Federal Reserve is responsible for controlling the money supply, while in the Euro area the respective institution is the ECB. Other central banks with significant impact on global finances are the Bank of Japan, People's Bank of China and the Bank of England.

When gold is used as money, the money supply can grow in either of two ways. First, the money supply can increase as the amount of gold increases by new gold mining at about 2% per year, but it can also increase more during periods of gold rushes and discoveries, such as when Columbus discovered the new world and brought gold back to Spain, or when gold was discovered in California in 1848. This kind of increase helps debtors, and causes inflation, as the value of gold goes down. Second, the money supply can increase when the value of gold goes up, as this makes existing stocks of gold more valuable. This kind of increase helps savers and creditors and is called deflation, where items for sale are increasingly less expensive in terms of gold. Deflation was the more typical situation for over a century when gold was used as money in the US from 1792 to 1913.

Social and psychological value of money

Money is universally valued; so much so, that we take its value as self-evident and in need of no explanation. Money today is valued for the products and services for which it can be exchanged, the security it provides against unexpected needs, the economic power it generates, the political influence it exerts, the social status it offers to those who possess it, the self-confidence and sense of accomplishment it fosters in those who earn it.

Theories abound to explain the economic value of money in terms of purchasing power. But in order to fully understand the value of money, economic theory is not sufficient. Money has acquired the all-pervasive value that it possesses today by a slow evolutionary process that can be most easily understood by tracing its social and psychological origins from ancient times. Money has to be viewed in a wider context as a social institution based on the consent of the population and as a psychological symbol based on the consent of the individual.

Linkages between money and other social institutions

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 of exchange and measure of value money, thus serving as a stimulant for the exchange of goods and services. As a medium for storage of value, it gave rise to banking. By creating and lending money, banks became catalysts for the further development of trade and industry. In the form of taxation, money supported the development of government. These linkages are direct expressions of the primary powers of money to facilitate transactions.

In addition, money exercises secondary influences on the society. Politically, the right to collect taxes helped monarchy centralize power and influence in a national government. At a later stage, the ever increasing need of that government for more funds made it increasingly dependent and subject to those sections of society that possessed or controlled large sums of money. The English Parliament eventually wrested power from the king by first acquiring the sole right to raise taxes, paving the way for democracy. Later the wealthy merchant class acquired increasing influence over the political establishment. Socially, 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.

Private currencies

In many countries, the issue of private paper currencies has been severely restricted by law.

In the US, the Free Banking Era lasted between 1837 and 1866. States, municipalities, private banks, railroad and construction companies, stores, restaurants, churches and individuals printed an estimated 8,000 different monies by 1860. If the issuer went bankrupt, closed, left town, or otherwise went out of business the note would be worthless. Such organizations earned the nickname of "wildcat banks" for a reputation of unreliability and that they were often situated in far-off, unpopulated locales that were said to be more apt to wildcats than people. On the other hand, according to Lawrence H. White's article in The Freeman: Ideas on Liberty - October 1993 "it turns out that “wildcat” banking is largely a myth. Although stories about crooked banking practices are entertaining—and for that reason have been repeated endlessly by textbooks—modern economic historians have found that there were in fact very few banks that fit any reasonable definition of wildcat bank." In Australia, the Bank Notes Tax Act of 1910 basically shut down the circulation of private currencies by imposing a prohibitive tax on the practice. Many other nations have similar such policies that eliminate private sector competition.

In Scotland and Northern Ireland private sector banks are licensed to print their own paper money by the government. Today privately issued electronic money is in circulation. Some of these private currencies are backed by historic forms of money such as gold, as in the case of digital gold currency. Transactions in these currencies represent an annual turnover value in billions of US dollars.

It is possible for privately issued money to be backed by any material, although some people argue about perishable materials. The material used to back money changes with the times. Gold, silver, and platinum now have, in some regards, less utility than they did previously (their electrical properties notwithstanding). This makes things such as energy (measured in joules), transport (measured in kilogramme*kilometre/hour), or food [1] more useful for backing money. It is important to understand that money is above all an agreement to use something as a medium of exchange. It is up to a community (or to whoever holds the power within a community) to decide whether money should be backed by a certain material or should be totally virtual.

Currency unions

During the 20th century, it was normal for all independent states to have their own national currency, managed by a central bank. In 1999, however, a number of countries in the European Union adopted a common currency, the euro. From 1999 to 2002, the euro was a common unit of account co-existing with national currencies which continued to circulated. In 2002, euro-denominated notes and coins were issued, and rapidly displaced the previous national currencies, including the French franc, German mark and Italian lira.

In addition, a number of countries, including he 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.

Anonymity

Some, but not all, forms of money are anonymous. To be anonymous:

In the opinion of all libertarians and most laissez-faire economists, money should not be subject to government tracking.
In the opinion of all libertarians and most laissez-faire economists, it should be usable for purchases in a black market.
It should not require equipment, tools or electricity to use.

Benchmark world currencies

These are the major currencies used in trading^[4].

Australia - Australian Dollar (AUD)
Canada - Canadian Dollar (CAD)
European Monetary Union (EUR-13) - 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

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 6:24
"For the love of money is the root of all evil: which while some coveted after, they have erred from the faith, and pierced themselves through with many sorrows." First Epistle to Timothy 6:10
"When it's a question of money, everybody is of the same religion." Voltaire
"Only when the last tree has died and the last river been poisoned and the last fish been caught will we realise we cannot eat money." Cree proverb
"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
"I spend money with reckless abandon. Last month I blew five thousand dollars at a reincarnation seminar. I got to thinking, what the hell, you only live once." Ronnie Shakes
"So you think that money is the root of all evil? Have you ever asked what is the root of money? Money is a tool of exchange, which can't exist unless there are goods produced and men able to produce them. Money is the material shape of the principle that men who wish to deal with one another must deal by trade and give value for value. Money is not the tool of the moochers, who claim your product by tears or of the looters, who take it from you by force. Money is made possible only by the men who produce. Is this what you consider evil?" Ayn Rand
"The study of money, above all other fields in economics, is one in which complexity is used to disguise truth or to evade truth, not to reveal it. The process by which banks creates money is so simple that mind is repelled." John Kenneth Galbraith
"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"

References

^ amosweb.com
^ Galbraith, J.K., Money: Whence it came, where it went, Penguin, UK, 1975, p.20-21.
^ Weatherford, J., "Indian Givers: How the Indians of the Americas Transformed the World", Ballantine Books, US 1988, p16
^ benchmark World Currencies at Bloomberg

External links

Current Currency Exchange Rates by cnn
Current Currency Exchange Rates by xe.com
Current Currency Exchange Rates by boc
Linguistic and Commodity Exchanges by Elmer G. Wiens. Examines the structural differences between barter and monetary commodity exchanges and oral and written linguistic exchanges.

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[1] sweb.com

[2] Galbraith, J.K., Money: Whence it came, where it went, Penguin, UK, 1975, p.20-21.

[3] Weatherford, J., "Indian Givers: How the Indians of the Americas Transformed the World", Ballantine Books, US 1988, p16

[4] rk World Currencies at Bloomberg

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