Money
In the modern world we take money for granted. However, pause for a moment and imagine what life would be like without money. Suppose that you want to consume a particular good or service, such as a pair of shoes. If money didn't exist, you would need to barter with the cobbler for the pair of shoes that you want. Barter is the process of directly exchanging one good or service for another. In order to purchase the pair of shoes, you would need to have something to trade for the shoes. If you specialized in growing peaches, you would need to bring enough bushels of peaches to the cobbler's shop to purchase the pair of shoes. If the cobbler wanted your peaches and you wanted his shoes, then a double coincidence of wants would exist and trade could take place.
But what if the cobbler didn't want your peaches? In that case you would have to find out what he did want, for example, beef. Then you would have to trade your peaches for beef and the beef for shoes. But what if the person selling beef had no desire for peaches, but instead wants a computer? Then you would have to trade your peaches for a computer—and it would take a lot of peaches to buy a computer. Then you would have to trade your computer for beef and the beef for shoes. But what if…? At some point it would become easier to make the shoes yourself or to just do without.
The Evolution of Money
Money evolved as a way of avoiding the complexities and difficulties of barter. Money is any asset that is recognized by an economic community as having value. Historically, such assets have included, among other things, shells, stone disks (which can be somewhat difficult to carry around), gold, and bank notes.
The modern monetary system has its roots in the gold of medieval Europe. In the Middle Ages, gold and gold coins were the common currency. However, the wealthy found that carrying large quantities of gold around was difficult and made them the target of thieves. To avoid carrying gold coins, people began depositing them for safekeeping with goldsmiths, who often had heavily guarded vaults in which to store their valuable inventories of gold. The goldsmiths charged a fee for their services and issued receipts, or gold notes, in the amount of the deposits. Exchanging these receipts was much simpler and safer than carrying around gold coins. In addition, the depositors could retrieve their gold on demand.
Goldsmiths during this time became aware that few people actually wanted their gold coins back when the gold notes were so easy to use for exchange. They therefore began lending some of the gold on deposit to borrowers who paid a fee, called interest. These goldsmiths were the precursors to our modern fractional reserve banking system.
Functions of Money
Regardless of what asset is recognized by an economic community as money, in general it serves three functions:
Money is a medium of exchange.
Money is a measure of value.
Money is a store of value.
Money as a medium of exchange. Used as a medium of exchange, money means that parties to a transaction no longer need to barter one good for another. Because money is accepted as a medium of exchange, you can sell your peaches for money and purchase the desired shoes with the proceeds of the sale. You no longer need to trade peaches—a lot of them—for a computer and then the computer for beef and then the beef for the shoes. As a medium of exchange, money tends to encourage specialization and division of labor, promoting economic efficiency.
Money is a measure of value. As a measure of value, money makes transactions significantly simpler. Instead of markets determining the price of peaches relative to computers and to beef and to shoes, as well as the price of computers relative to beef and to shoes, as well as the price of beef relative to shoes (i.e., a total of six prices for only four goods), the markets only need to determine the price of each of the four goods in terms of money. If we were to add a fifth good to our simple economy, then we would add four more prices to the number of good-for-good prices that the markets must determine. As the number of goods in our economy grew, the number of good-for-good prices would grow rapidly. In an economy with ten goods, there would be forty-five good-for-good prices but only ten money prices. In an economy with twenty goods there would be one hundred and ninety good-for-good prices but only twenty money prices. Imagine all of the good-for-good prices in a more realistic economy with thousands of goods and services available.
Using money as a measure of value reduces the number of prices determined in markets and vastly reduces the cost of collecting price information for market participants. Instead of focusing on such information, market participants can focus their effort on producing the good or service in which they specialize.
Money as a store of value. Money can also serve as a store of value, since it can quickly be exchanged for desired goods and services. Many assets can be used as a store of value, including stocks, bonds, and real estate. However, there are transaction costs associated with converting these assets into money in order to purchase a desired good or service. These transaction costs could include monetary fees as well as time delays involved in the liquidation process.
In contrast, money is a poor store of value during periods of inflation, while the value of real estate tends to appreciate during such periods. Thus, the benefits of holding money must by balanced against the risks of holding money.
Summary
Money simplifies the exchange of goods and services and facilitates specialization and division of labor. It does this by serving as a medium of exchange, as a measure of value, and as a store of value.
[Article by: DENISE WOODBURY]
money
Idioms beginning with money:money burns a hole in one's pocketmoney talksSee also coin money; color of one's money; easy money; even money; fool and his money are soon parted; for one's money; funny money; get one's money's worth; hush money; in the money; made of money; not for love or money; on the money; pay your money and take your choice; pin money; pocket money; put money on; put one's money where one's mouth is; rolling in it (money); run for one's money; throw good money after bad; time is money.
money
Commodity accepted by general consent as a medium of economic exchange. It is the medium in which prices and values are expressed; it circulates from person to person and country to country, thus facilitating trade. Throughout history various commodities have been used as money, including seashells, beads, and cattle, but since the 17th century the most common forms have been metal coins, paper notes, and bookkeeping entries. In standard economic theory, money is held to have four functions: to serve as a medium of exchange universally accepted in return for goods and services; to act as a measure of value, making possible the operation of the price system and the calculation of cost, profit, and loss; to serve as a standard of deferred payments, the unit in which loans are made and future transactions are fixed; and to provide a means of storing wealth not immediately required for use. Metals, especially gold and silver, have been used for money for at least 4,000 years; standardized coins have been minted for perhaps 2,600 years. In the late 18th and early 19th century, banks began to issue notes redeemable in gold or silver, which became the principal money of industrial economies. Temporarily during World War I and permanently from the 1930s, most nations abandoned the gold standard. To most individuals today, money consists of coins, notes, and bank deposits. In terms of the economy, however, the total money supply is several times as large as the sum total of individual money holdings so defined, since most of the deposits placed in banks are loaned out, thus multiplying the money supply several times over. See also soft money.
money, term that actually refers to two concepts: the abstract unit of account in terms of which the value of goods, services, and obligations can be compared; and anything that is widely established as a means of payment. Frequently the standard of value also serves as a medium of exchange, but that is not always the case.
Evolution
Many ancient communities, for instance, took cattle as their standard of value but used more manageable objects as means of payment. Exchange involving the use of money is a great improvement over barter, since it permits elaborate specialization and provides generalized purchasing power that the participants in the exchange may use in the future. The growth of monetary institutions has largely paralleled that of trade and industry; today almost all economic activity is concerned with the making and spending of money incomes.
From the earliest times precious metals have had wide monetary use, owing to convenience of handling, durability, divisibility, and the high intrinsic value commonly attached to them. Whether an article is to be regarded as money does not, however, depend on its value as a commodity, except where intrinsic worth is necessary to make it generally acceptable in exchange; the relation between the face value of an object used as money and its commodity value has actually become increasingly remote (see coin). Paper currency first appeared about 300 years ago; it was usually backed by some “standard” commodity of intrinsic value into which it could be freely converted on demand, but even during the early development of currency, issuance of inconvertible paper money, also called fiat money, was not infrequent (see, for example, Law, John). The world's first durable plastic currency was introduced by Australia in a special issue in 1988 and in a regular issue in 1992. Plastic bills are more resistant to counterfeiting than paper, and a number of countries now issue some plastic currency.
The importance of money has been variously interpreted. While the advocates of mercantilism tended to identify money with wealth, the classical economists, e.g., John Stuart Mill, usually considered money as a veil obscuring real economic phenomena. Since the mid-20th cent., a group known as the monetarists has given increasing attention to the role of money in determining national income and economic fluctuations.
The Monetary System of the United States
The monetary system of the United States was based on bimetallism during most of the 19th cent. A full gold standard was in effect from 1900 to 1933, providing for free coinage of gold and full convertibility of currency into gold coin; the volume of money in circulation was closely related to the gold supply. The passage of the Gold Reserve Act of 1934, which put the country on a modified gold standard, presaged the end of the gold-based monetary system in domestic exchange. Under this system, the dollar was legally defined as having a certain, fixed value in gold. While gold was still thought to be important for maintenance of confidence in the dollar, its connection with the actual use of money was at best vague. The 1934 act stipulated that gold could not be used as a medium of domestic exchange. More recently, a number of measures have de-emphasized the dollar's dependence on gold; since the early 1970s, practically all U.S. currency, paper or coin, is essentially fiat money.
Under the Legal Tender Act of 1933, all American coin and paper money in circulation is now legal tender, i.e., under the law it must be accepted at face value by creditors in payment of any debt, public or private. Most of the currency circulating in the United States consists of Federal Reserve notes, which are issued in denominations ranging from $1 to $100 by the Federal Reserve System, are guaranteed by the U.S. government, and are secured by government securities and eligible commercial paper. A small fraction of the currency supply is made up of the various types of coin, none of which has a commodity value equal to its face value. Finally, an even smaller part of the circulating currency is composed of bills that are no longer issued, such as silver certificates, which were redeemable in silver until 1967, and bills in denominations between $500 and $100,000, which have not been issued since 1969. Today, currency and coin are less widely used as a means of payment than checks, debit cards, and credit cards; demand deposits (checking accounts) are, therefore, generally considered part of the money supply. Starting in 1996, the Federal Reserve undertook the redesign of all paper bills, chiefly to deter a new wave of counterfeiting that uses computer technology; further changes, including colors in addition to green, were introduced in 2003. (See banking; on the regulation of the supply, availability, and cost of money, see Federal Reserve System and interest.) Certain assets, sometimes called near-monies, are similar to money in that they can usually be readily converted into cash without loss; they include, for example, time deposits and very short-term obligations of the federal government. Funds that are frequently transferred from country to country for maximum advantage are called hot monies. The technical definition of the nation's aggregate money supply includes three measures of money: M-1, the sum of all currency and demand deposits held by consumers and businesses; M-2 is M-1 plus all savings accounts, time deposits (e.g., certificates of deposit), and smaller money-market accounts; M-3 is M-2 plus large-denomination time deposits held by corporations and financial institutions and money-market funds held by financial institutions.
Electronic Money
Electronic payment systems, already in place for use by credit-card processors, were adapted in the 1990s for use in electronic commerce (e-commerce) on the Internet. Such “digital cash” payments allow customers to pay for on-line orders using secure accounts established with specialized financial institutions; related technology is used for on-line payment of bills.
Bibliography
See J. M. Keynes, General Theory of Employment, Interest, and Money (1936); J. Niehans, The Theory of Money (1980); J. Wheatley, An Essay on the Theory of Money and Principles of Commerce (1983); A. Schwartz, Money in Historical Perspective (1987); J. Hicks, A Market Theory of Money (1989); C. Rogers, Money, Interest and Capital (1989); J. Goodwin, Greenback: The Almighty Dollar and the Invention of America (2002).
Money
Money that comes from a pact with the devil is of poor quality, and such wealth, like the fairy-money, generally turns to earth, or to lead, toads, or anything else worthless or repulsive. St. Gregory of Tours (d. 594 C.E.) told a illustrative story: "A youth received a piece of folded paper from a stranger, who told him that he could get from it as much money as he wished, so long as he did not unfold it. The youth drew many gold pieces from the papers, but at length curiosity overcame him, he unfolded it and discovered within the claws of a cat and a bear, the feet of a toad and other repulsive fragments, while at the same moment his wealth disappeared."
It is said that an Irishman outsmarted the devil. In his book Irish Witchcraft and Demonology (1913; 1973), St. John D. Seymour told the amusing story of Joseph Damer of Tipperary County, who made a bargain with the devil to sell his soul for a top-boot full of gold. On the appointed day, the devil was ushered into the living room, where a top-boot stood in the center of the floor. The devil poured gold into it, but to his surprise, it remained empty. He hastened away for more gold, but the top-boot would not fill, even after repeated efforts. At length, in sheer disgust, the devil departed. Afterward it was claimed that the shrewd Irishman had taken the sole off the boot and fastened it over a hole in the floor. Underneath was a series of large cellars, where men waited with shovels to remove each shower of gold as it came down.
In popular superstition it is supposed that if a person hears the cuckoo for the first time with money in his pocket, he will have some all the year, while if he greets the new moon for the first time in the same fortunate condition, he will not lack money throughout the month.
money
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.[1] 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.
History
Main article: History of money
See also: Social evolution of money
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, 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 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 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.
Coinage
Main article: Coin
Coins are commonly used for the smaller denominations of currency in a country's monetary system. In the United States for example, coins come in 1, 5, 10, 25, and 50 cents, and also 1 dollar. In Europe, coins come in 1, 2, 5, 10, 20, and 50 euro cents, and also 1 euro and 2 euros. The larger denominations of currency in both regions consist of paper money. The same general phenomenon can be observed in the Philippines, Mexico, Singapore, China, Canada, South Africa, and many other societies throughout the world.
The use of coins made of valuable material such as gold, silver of copper is commonly attributed to Croesus of Lydia in the 6th century BCE. However, some authorities claim a significantly earlier origin for coinage in China [2]
The rise of fiat currencies
The bulkiness and limited transportability of some forms of commodity money led to the rise of symbolic substitutes. 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. During the 19th Century commercial banks in Europe and North America issued their own banknotes based on the same principle of partial backing. In the US, the Free Banking Era lasted between 1837 and 1866.
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 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 symbolic money and are commonly used for small person-to-person transactions. There are also less tangible forms of money, which nevertheless serve the same functions as money. 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.[citation needed] 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.[citation needed]
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.
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 circulate. 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 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
Bloomberg L.P. lists the following major currencies used in trading[3].
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
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
Main article: Integration of money with 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. It has 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. The English Parliament eventually wrested power from the king by first acquiring the sole right to raise taxes, paving the way for democracy.
Money has also played an important role in population migrations and the shifting balance of power between individuals, the state and religious institutions. The desire to add Jewish wealth to Catholic and Spanish treasuries helped trigger the Spanish inquisition.[citation needed] Many Catholics fled England after Henry the 8th dissolved the catholic monasteries and confiscated their treasuries.[citation needed]
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. In some cases, particularly in Italy, oligarchies of rich merchants, rather than hereditary rulers governed.
Money also played a limiting role in religious discrimination. Despite the Catholic church's many attempts to isolate Jews from the surrounding Christian society, Jews were periodically invited to move into a country as a way of stimulating trade across Europe and the far east. Because Jews were found all along the trade routes and their use of Hebrew provided a common language for trade from Europe to China. Their historic role in banking was as much stimulated by their unique position on trade routes as by the oft cited Catholic edicts against usury[citation needed]
Economic characteristics
Money is generally considered to have the following characteristics, which are summed up in a rhyme found older economics textbooks and a primer: "Money is a matter of functions four, a medium, a measure, a standard, a store."
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.
Medium of exchange
Main article: Medium of exchange
A medium of exchange is an intermediary used in trade. An effective medium of exchange should have the following characteristics:
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 or 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.
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 pre-requisite for the formulation of commercial agreements that involve debt.
An effective unit of account 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.
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.
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 storage of value.
An effective store of value should have the following characteristics:
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.
Market liquidity
Main article: Market liquidity
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.
Liquid financial instruments are easily tradable and have a 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, not all money is created equal.
One early theoretician, Ludwig von Mises, argued for the importance of distinguishing between three types of money: commodity money, fiat money, and credit money. Each carries different economic strengths and liabilities - a point driven home in his book The Theory of Money and Credit.
Modern monetary theory also distinguishes between 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 that is both used as a general purpose medium of exchange and as a tradable commodity in its own right.[4]
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. In the 1500 and 1600's 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.[5] In addition, the relative value of silver to gold shifted dramatically downward.[6] More recently, from 1980 to 2001, gold was a particularly 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.
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. This has happened periodically in the United States, eventually causing it to move away from pure silver nickels and pure copper pennies.[citation needed] 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.[citation needed]
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.
Stability aside, commodity based currencies are limiting in a rapidly growing or very active economy. The supply of money in an economy must be equal or greater than the volume of trade. If commodities are used as money, then the money supply must equal the total amount of goods and services sold. In a large economy, the volume of trade can easily outstrip the supply of any one commodity.
This problem is compounded by the fact that money also serves as a store of value. This encourages hoarding and takes the commodity money out circulation, reducing the supply. The supply of circulating commodity currency is further reduced by the fact that commodity moneys also have competing non-monetary uses. For example, gold and silver is used in jewelery and nickel and copper have important industrial uses.
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
Main article: Fiat money
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.[4]
Fiat money provides 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. Its sole use is as a medium of exchange so its supply is not limited by competing alternate uses. 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. For example, the US government will replace mutilated paper money if at least half of the bill can be reconstructed.[7]. 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. 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. In order to reduce replacement costs, many countries are converting to plastic bills. For example, 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.
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
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[4]. 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[4].
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 recieve 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. [8]
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.
Money supply
Main article: Money supply
Components of US money supply (M1, M2, and M3) since 1959
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.
Monetary policy
Main article: Monetary policy
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. For example, it is clearly stated in the Federal Reserve Act that the Board of Governors and the Federal Open Market Committee should seek “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” [9]
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. This happened in Russia, for instance, after the fall of the Soviet Union.
Governments and central banks have taken both regulatory and free market approaches to monetary policy. Some of the various tools used to control the money supply include:
currency purchases or sales
increasing or lowering government spending
increasing or lowering government borrowing
changing the rate at which the government loans or borrows money
manipulation of exchange rates
taxation or tax breaks on imports or exports of capital into a country
raising or lowering bank reserve requirements
regulation or prohibition of private currencies
For many years much of monetary policy was influenced by an economic theory known as monetarism. Monetarism is an economic theory which argues that management of the money supply should be the primary means of regulating economic activity. The stability of the demand for money prior to the 1980s was a key finding of Milton Friedman and Anna Schwartz [10] supported by the work of David Laidler[11], and many others.
Technical, institutional, and legal changes changed the nature of the demand for money during the 1980s and the influence of monetarism has since decreased.
Social and psychological value of money
Main article: Social and psychological value of money
Money is universally valued; 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, and also 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.
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 a root of all kinds of 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"
See also
Category:Money
Wikiquote has a collection of quotations related to:
Money
Wikimedia Commons has media related to:
Money
Economics
List of finance topics
Coin of account
Counterfeit, for Counterfeiting of Money
Credit money
Currency market
Electronic money
World currency
Federal Reserve
Fractional reserve banking
Full reserve banking
Labor-time voucher
List of songs about money
Local Exchange Trading Systems
Numismatics - Collection and study of money
Seignorage
Standard of deferred payment
Free Market
Gift economy
Gelt
Wealth
Usury
References
^ amosweb.com
^ Quiggin, A. Hingston (1979). A survey of primitive money : the beginnings of currency. New York: AMS Press.
^ benchmark World Currencies at Bloomberg
^ a b c d
^ 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
^ Shredded and multilated. Bureau of engraving and printing. Last accessed 2007-05-09
^ Barry Eichengreen and Kris Mitchener. The Great Depression as a Credit Boom Gone Wrong. Last accessed 2007-05-08.
^ The Federal Reserve. 'Monetary Policy and the Economy". Board of Governors of the Federal Reserve System, (2005-07-05). Retrieved 2007-05-15.
^ Milton Friedman, Anna Jacobson Schwartz, (1971). Monetary History of the United States, 1867-1960. Princeton, N.J: Princeton University Press. ISBN 0-691-00354-8.
^ David Laidler,. Money and Macroeconomics: The Selected Essays of David Laidler (Economists of the Twentieth Century). Edward Elgar Publishing. ISBN 1-85898-596-X.
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.
In the modern world we take money for granted. However, pause for a moment and imagine what life would be like without money. Suppose that you want to consume a particular good or service, such as a pair of shoes. If money didn't exist, you would need to barter with the cobbler for the pair of shoes that you want. Barter is the process of directly exchanging one good or service for another. In order to purchase the pair of shoes, you would need to have something to trade for the shoes. If you specialized in growing peaches, you would need to bring enough bushels of peaches to the cobbler's shop to purchase the pair of shoes. If the cobbler wanted your peaches and you wanted his shoes, then a double coincidence of wants would exist and trade could take place.
But what if the cobbler didn't want your peaches? In that case you would have to find out what he did want, for example, beef. Then you would have to trade your peaches for beef and the beef for shoes. But what if the person selling beef had no desire for peaches, but instead wants a computer? Then you would have to trade your peaches for a computer—and it would take a lot of peaches to buy a computer. Then you would have to trade your computer for beef and the beef for shoes. But what if…? At some point it would become easier to make the shoes yourself or to just do without.
The Evolution of Money
Money evolved as a way of avoiding the complexities and difficulties of barter. Money is any asset that is recognized by an economic community as having value. Historically, such assets have included, among other things, shells, stone disks (which can be somewhat difficult to carry around), gold, and bank notes.
The modern monetary system has its roots in the gold of medieval Europe. In the Middle Ages, gold and gold coins were the common currency. However, the wealthy found that carrying large quantities of gold around was difficult and made them the target of thieves. To avoid carrying gold coins, people began depositing them for safekeeping with goldsmiths, who often had heavily guarded vaults in which to store their valuable inventories of gold. The goldsmiths charged a fee for their services and issued receipts, or gold notes, in the amount of the deposits. Exchanging these receipts was much simpler and safer than carrying around gold coins. In addition, the depositors could retrieve their gold on demand.
Goldsmiths during this time became aware that few people actually wanted their gold coins back when the gold notes were so easy to use for exchange. They therefore began lending some of the gold on deposit to borrowers who paid a fee, called interest. These goldsmiths were the precursors to our modern fractional reserve banking system.
Functions of Money
Regardless of what asset is recognized by an economic community as money, in general it serves three functions:
Money is a medium of exchange.
Money is a measure of value.
Money is a store of value.
Money as a medium of exchange. Used as a medium of exchange, money means that parties to a transaction no longer need to barter one good for another. Because money is accepted as a medium of exchange, you can sell your peaches for money and purchase the desired shoes with the proceeds of the sale. You no longer need to trade peaches—a lot of them—for a computer and then the computer for beef and then the beef for the shoes. As a medium of exchange, money tends to encourage specialization and division of labor, promoting economic efficiency.
Money is a measure of value. As a measure of value, money makes transactions significantly simpler. Instead of markets determining the price of peaches relative to computers and to beef and to shoes, as well as the price of computers relative to beef and to shoes, as well as the price of beef relative to shoes (i.e., a total of six prices for only four goods), the markets only need to determine the price of each of the four goods in terms of money. If we were to add a fifth good to our simple economy, then we would add four more prices to the number of good-for-good prices that the markets must determine. As the number of goods in our economy grew, the number of good-for-good prices would grow rapidly. In an economy with ten goods, there would be forty-five good-for-good prices but only ten money prices. In an economy with twenty goods there would be one hundred and ninety good-for-good prices but only twenty money prices. Imagine all of the good-for-good prices in a more realistic economy with thousands of goods and services available.
Using money as a measure of value reduces the number of prices determined in markets and vastly reduces the cost of collecting price information for market participants. Instead of focusing on such information, market participants can focus their effort on producing the good or service in which they specialize.
Money as a store of value. Money can also serve as a store of value, since it can quickly be exchanged for desired goods and services. Many assets can be used as a store of value, including stocks, bonds, and real estate. However, there are transaction costs associated with converting these assets into money in order to purchase a desired good or service. These transaction costs could include monetary fees as well as time delays involved in the liquidation process.
In contrast, money is a poor store of value during periods of inflation, while the value of real estate tends to appreciate during such periods. Thus, the benefits of holding money must by balanced against the risks of holding money.
Summary
Money simplifies the exchange of goods and services and facilitates specialization and division of labor. It does this by serving as a medium of exchange, as a measure of value, and as a store of value.
[Article by: DENISE WOODBURY]
money
Idioms beginning with money:money burns a hole in one's pocketmoney talksSee also coin money; color of one's money; easy money; even money; fool and his money are soon parted; for one's money; funny money; get one's money's worth; hush money; in the money; made of money; not for love or money; on the money; pay your money and take your choice; pin money; pocket money; put money on; put one's money where one's mouth is; rolling in it (money); run for one's money; throw good money after bad; time is money.
money
Commodity accepted by general consent as a medium of economic exchange. It is the medium in which prices and values are expressed; it circulates from person to person and country to country, thus facilitating trade. Throughout history various commodities have been used as money, including seashells, beads, and cattle, but since the 17th century the most common forms have been metal coins, paper notes, and bookkeeping entries. In standard economic theory, money is held to have four functions: to serve as a medium of exchange universally accepted in return for goods and services; to act as a measure of value, making possible the operation of the price system and the calculation of cost, profit, and loss; to serve as a standard of deferred payments, the unit in which loans are made and future transactions are fixed; and to provide a means of storing wealth not immediately required for use. Metals, especially gold and silver, have been used for money for at least 4,000 years; standardized coins have been minted for perhaps 2,600 years. In the late 18th and early 19th century, banks began to issue notes redeemable in gold or silver, which became the principal money of industrial economies. Temporarily during World War I and permanently from the 1930s, most nations abandoned the gold standard. To most individuals today, money consists of coins, notes, and bank deposits. In terms of the economy, however, the total money supply is several times as large as the sum total of individual money holdings so defined, since most of the deposits placed in banks are loaned out, thus multiplying the money supply several times over. See also soft money.
money, term that actually refers to two concepts: the abstract unit of account in terms of which the value of goods, services, and obligations can be compared; and anything that is widely established as a means of payment. Frequently the standard of value also serves as a medium of exchange, but that is not always the case.
Evolution
Many ancient communities, for instance, took cattle as their standard of value but used more manageable objects as means of payment. Exchange involving the use of money is a great improvement over barter, since it permits elaborate specialization and provides generalized purchasing power that the participants in the exchange may use in the future. The growth of monetary institutions has largely paralleled that of trade and industry; today almost all economic activity is concerned with the making and spending of money incomes.
From the earliest times precious metals have had wide monetary use, owing to convenience of handling, durability, divisibility, and the high intrinsic value commonly attached to them. Whether an article is to be regarded as money does not, however, depend on its value as a commodity, except where intrinsic worth is necessary to make it generally acceptable in exchange; the relation between the face value of an object used as money and its commodity value has actually become increasingly remote (see coin). Paper currency first appeared about 300 years ago; it was usually backed by some “standard” commodity of intrinsic value into which it could be freely converted on demand, but even during the early development of currency, issuance of inconvertible paper money, also called fiat money, was not infrequent (see, for example, Law, John). The world's first durable plastic currency was introduced by Australia in a special issue in 1988 and in a regular issue in 1992. Plastic bills are more resistant to counterfeiting than paper, and a number of countries now issue some plastic currency.
The importance of money has been variously interpreted. While the advocates of mercantilism tended to identify money with wealth, the classical economists, e.g., John Stuart Mill, usually considered money as a veil obscuring real economic phenomena. Since the mid-20th cent., a group known as the monetarists has given increasing attention to the role of money in determining national income and economic fluctuations.
The Monetary System of the United States
The monetary system of the United States was based on bimetallism during most of the 19th cent. A full gold standard was in effect from 1900 to 1933, providing for free coinage of gold and full convertibility of currency into gold coin; the volume of money in circulation was closely related to the gold supply. The passage of the Gold Reserve Act of 1934, which put the country on a modified gold standard, presaged the end of the gold-based monetary system in domestic exchange. Under this system, the dollar was legally defined as having a certain, fixed value in gold. While gold was still thought to be important for maintenance of confidence in the dollar, its connection with the actual use of money was at best vague. The 1934 act stipulated that gold could not be used as a medium of domestic exchange. More recently, a number of measures have de-emphasized the dollar's dependence on gold; since the early 1970s, practically all U.S. currency, paper or coin, is essentially fiat money.
Under the Legal Tender Act of 1933, all American coin and paper money in circulation is now legal tender, i.e., under the law it must be accepted at face value by creditors in payment of any debt, public or private. Most of the currency circulating in the United States consists of Federal Reserve notes, which are issued in denominations ranging from $1 to $100 by the Federal Reserve System, are guaranteed by the U.S. government, and are secured by government securities and eligible commercial paper. A small fraction of the currency supply is made up of the various types of coin, none of which has a commodity value equal to its face value. Finally, an even smaller part of the circulating currency is composed of bills that are no longer issued, such as silver certificates, which were redeemable in silver until 1967, and bills in denominations between $500 and $100,000, which have not been issued since 1969. Today, currency and coin are less widely used as a means of payment than checks, debit cards, and credit cards; demand deposits (checking accounts) are, therefore, generally considered part of the money supply. Starting in 1996, the Federal Reserve undertook the redesign of all paper bills, chiefly to deter a new wave of counterfeiting that uses computer technology; further changes, including colors in addition to green, were introduced in 2003. (See banking; on the regulation of the supply, availability, and cost of money, see Federal Reserve System and interest.) Certain assets, sometimes called near-monies, are similar to money in that they can usually be readily converted into cash without loss; they include, for example, time deposits and very short-term obligations of the federal government. Funds that are frequently transferred from country to country for maximum advantage are called hot monies. The technical definition of the nation's aggregate money supply includes three measures of money: M-1, the sum of all currency and demand deposits held by consumers and businesses; M-2 is M-1 plus all savings accounts, time deposits (e.g., certificates of deposit), and smaller money-market accounts; M-3 is M-2 plus large-denomination time deposits held by corporations and financial institutions and money-market funds held by financial institutions.
Electronic Money
Electronic payment systems, already in place for use by credit-card processors, were adapted in the 1990s for use in electronic commerce (e-commerce) on the Internet. Such “digital cash” payments allow customers to pay for on-line orders using secure accounts established with specialized financial institutions; related technology is used for on-line payment of bills.
Bibliography
See J. M. Keynes, General Theory of Employment, Interest, and Money (1936); J. Niehans, The Theory of Money (1980); J. Wheatley, An Essay on the Theory of Money and Principles of Commerce (1983); A. Schwartz, Money in Historical Perspective (1987); J. Hicks, A Market Theory of Money (1989); C. Rogers, Money, Interest and Capital (1989); J. Goodwin, Greenback: The Almighty Dollar and the Invention of America (2002).
Money
Money that comes from a pact with the devil is of poor quality, and such wealth, like the fairy-money, generally turns to earth, or to lead, toads, or anything else worthless or repulsive. St. Gregory of Tours (d. 594 C.E.) told a illustrative story: "A youth received a piece of folded paper from a stranger, who told him that he could get from it as much money as he wished, so long as he did not unfold it. The youth drew many gold pieces from the papers, but at length curiosity overcame him, he unfolded it and discovered within the claws of a cat and a bear, the feet of a toad and other repulsive fragments, while at the same moment his wealth disappeared."
It is said that an Irishman outsmarted the devil. In his book Irish Witchcraft and Demonology (1913; 1973), St. John D. Seymour told the amusing story of Joseph Damer of Tipperary County, who made a bargain with the devil to sell his soul for a top-boot full of gold. On the appointed day, the devil was ushered into the living room, where a top-boot stood in the center of the floor. The devil poured gold into it, but to his surprise, it remained empty. He hastened away for more gold, but the top-boot would not fill, even after repeated efforts. At length, in sheer disgust, the devil departed. Afterward it was claimed that the shrewd Irishman had taken the sole off the boot and fastened it over a hole in the floor. Underneath was a series of large cellars, where men waited with shovels to remove each shower of gold as it came down.
In popular superstition it is supposed that if a person hears the cuckoo for the first time with money in his pocket, he will have some all the year, while if he greets the new moon for the first time in the same fortunate condition, he will not lack money throughout the month.
money
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.[1] 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.
History
Main article: History of money
See also: Social evolution of money
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, 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 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 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.
Coinage
Main article: Coin
Coins are commonly used for the smaller denominations of currency in a country's monetary system. In the United States for example, coins come in 1, 5, 10, 25, and 50 cents, and also 1 dollar. In Europe, coins come in 1, 2, 5, 10, 20, and 50 euro cents, and also 1 euro and 2 euros. The larger denominations of currency in both regions consist of paper money. The same general phenomenon can be observed in the Philippines, Mexico, Singapore, China, Canada, South Africa, and many other societies throughout the world.
The use of coins made of valuable material such as gold, silver of copper is commonly attributed to Croesus of Lydia in the 6th century BCE. However, some authorities claim a significantly earlier origin for coinage in China [2]
The rise of fiat currencies
The bulkiness and limited transportability of some forms of commodity money led to the rise of symbolic substitutes. 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. During the 19th Century commercial banks in Europe and North America issued their own banknotes based on the same principle of partial backing. In the US, the Free Banking Era lasted between 1837 and 1866.
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 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 symbolic money and are commonly used for small person-to-person transactions. There are also less tangible forms of money, which nevertheless serve the same functions as money. 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.[citation needed] 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.[citation needed]
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.
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 circulate. 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 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
Bloomberg L.P. lists the following major currencies used in trading[3].
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
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
Main article: Integration of money with 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. It has 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. The English Parliament eventually wrested power from the king by first acquiring the sole right to raise taxes, paving the way for democracy.
Money has also played an important role in population migrations and the shifting balance of power between individuals, the state and religious institutions. The desire to add Jewish wealth to Catholic and Spanish treasuries helped trigger the Spanish inquisition.[citation needed] Many Catholics fled England after Henry the 8th dissolved the catholic monasteries and confiscated their treasuries.[citation needed]
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. In some cases, particularly in Italy, oligarchies of rich merchants, rather than hereditary rulers governed.
Money also played a limiting role in religious discrimination. Despite the Catholic church's many attempts to isolate Jews from the surrounding Christian society, Jews were periodically invited to move into a country as a way of stimulating trade across Europe and the far east. Because Jews were found all along the trade routes and their use of Hebrew provided a common language for trade from Europe to China. Their historic role in banking was as much stimulated by their unique position on trade routes as by the oft cited Catholic edicts against usury[citation needed]
Economic characteristics
Money is generally considered to have the following characteristics, which are summed up in a rhyme found older economics textbooks and a primer: "Money is a matter of functions four, a medium, a measure, a standard, a store."
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.
Medium of exchange
Main article: Medium of exchange
A medium of exchange is an intermediary used in trade. An effective medium of exchange should have the following characteristics:
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 or 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.
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 pre-requisite for the formulation of commercial agreements that involve debt.
An effective unit of account 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.
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.
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 storage of value.
An effective store of value should have the following characteristics:
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.
Market liquidity
Main article: Market liquidity
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.
Liquid financial instruments are easily tradable and have a 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, not all money is created equal.
One early theoretician, Ludwig von Mises, argued for the importance of distinguishing between three types of money: commodity money, fiat money, and credit money. Each carries different economic strengths and liabilities - a point driven home in his book The Theory of Money and Credit.
Modern monetary theory also distinguishes between 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 that is both used as a general purpose medium of exchange and as a tradable commodity in its own right.[4]
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. In the 1500 and 1600's 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.[5] In addition, the relative value of silver to gold shifted dramatically downward.[6] More recently, from 1980 to 2001, gold was a particularly 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.
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. This has happened periodically in the United States, eventually causing it to move away from pure silver nickels and pure copper pennies.[citation needed] 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.[citation needed]
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.
Stability aside, commodity based currencies are limiting in a rapidly growing or very active economy. The supply of money in an economy must be equal or greater than the volume of trade. If commodities are used as money, then the money supply must equal the total amount of goods and services sold. In a large economy, the volume of trade can easily outstrip the supply of any one commodity.
This problem is compounded by the fact that money also serves as a store of value. This encourages hoarding and takes the commodity money out circulation, reducing the supply. The supply of circulating commodity currency is further reduced by the fact that commodity moneys also have competing non-monetary uses. For example, gold and silver is used in jewelery and nickel and copper have important industrial uses.
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
Main article: Fiat money
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.[4]
Fiat money provides 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. Its sole use is as a medium of exchange so its supply is not limited by competing alternate uses. 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. For example, the US government will replace mutilated paper money if at least half of the bill can be reconstructed.[7]. 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. 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. In order to reduce replacement costs, many countries are converting to plastic bills. For example, 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.
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
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[4]. 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[4].
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 recieve 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. [8]
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.
Money supply
Main article: Money supply
Components of US money supply (M1, M2, and M3) since 1959
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.
Monetary policy
Main article: Monetary policy
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. For example, it is clearly stated in the Federal Reserve Act that the Board of Governors and the Federal Open Market Committee should seek “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” [9]
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. This happened in Russia, for instance, after the fall of the Soviet Union.
Governments and central banks have taken both regulatory and free market approaches to monetary policy. Some of the various tools used to control the money supply include:
currency purchases or sales
increasing or lowering government spending
increasing or lowering government borrowing
changing the rate at which the government loans or borrows money
manipulation of exchange rates
taxation or tax breaks on imports or exports of capital into a country
raising or lowering bank reserve requirements
regulation or prohibition of private currencies
For many years much of monetary policy was influenced by an economic theory known as monetarism. Monetarism is an economic theory which argues that management of the money supply should be the primary means of regulating economic activity. The stability of the demand for money prior to the 1980s was a key finding of Milton Friedman and Anna Schwartz [10] supported by the work of David Laidler[11], and many others.
Technical, institutional, and legal changes changed the nature of the demand for money during the 1980s and the influence of monetarism has since decreased.
Social and psychological value of money
Main article: Social and psychological value of money
Money is universally valued; 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, and also 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.
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 a root of all kinds of 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"
See also
Category:Money
Wikiquote has a collection of quotations related to:
Money
Wikimedia Commons has media related to:
Money
Economics
List of finance topics
Coin of account
Counterfeit, for Counterfeiting of Money
Credit money
Currency market
Electronic money
World currency
Federal Reserve
Fractional reserve banking
Full reserve banking
Labor-time voucher
List of songs about money
Local Exchange Trading Systems
Numismatics - Collection and study of money
Seignorage
Standard of deferred payment
Free Market
Gift economy
Gelt
Wealth
Usury
References
^ amosweb.com
^ Quiggin, A. Hingston (1979). A survey of primitive money : the beginnings of currency. New York: AMS Press.
^ benchmark World Currencies at Bloomberg
^ a b c d
^ 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
^ Shredded and multilated. Bureau of engraving and printing. Last accessed 2007-05-09
^ Barry Eichengreen and Kris Mitchener. The Great Depression as a Credit Boom Gone Wrong. Last accessed 2007-05-08.
^ The Federal Reserve. 'Monetary Policy and the Economy". Board of Governors of the Federal Reserve System, (2005-07-05). Retrieved 2007-05-15.
^ Milton Friedman, Anna Jacobson Schwartz, (1971). Monetary History of the United States, 1867-1960. Princeton, N.J: Princeton University Press. ISBN 0-691-00354-8.
^ David Laidler,. Money and Macroeconomics: The Selected Essays of David Laidler (Economists of the Twentieth Century). Edward Elgar Publishing. ISBN 1-85898-596-X.
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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