What is Money?

Seems a simple question but the definitions of money and credit and their importance are aggressively debated by the best economic minds. Read on to see why.

Money is anything that is generally accepted as payment for goods and services and repayment of debts. Conventional opinion has it that money includes currency (circulating currency with legal tender status), and various forms of financial accounts such as savings, deposit, cheque and term deposits.

Money is an important part of an economy. With out money, two parties to a transaction must not only agree on a ‘price’, but also the medium of exchange. For example, I might well believe the car wash was worth two goats, but I may only have two sheep to pay with (which might be unacceptable to the car washer). Such friction results in higher economic costs.

Money is considered to be 1) a store of value, 2) a unit of account, and 3) a medium of exchange. Noted economists argue for distinguishing among different types of money as follows:

1. Commodity money is that actually contains its purported economic value. That is, a gold coin stamped ‘$50’ is actually worth $50 in real gold value. Historical examples of commodity money include gold/silver coins, copper, shells, precious stones and so on.
2. Representative money consists of token coins, notes or electronic certificates that can be swapped for a quantity of real commodity such as gold. It represents a real and direct relationship to a known quantity. For example, the US 1913 $50 Gold Certificate was “Fifty Dollars in Gold Coin Payable To The Bearer On Demand.”
3. Credit money is any future claim, such as an I.O.U., against a physical or legal person that can be used to purchase goods and services. Other examples include treasury, savings or corporate bonds, or bank money market account not immediately redeemable.
4. Fiat money is any money whose value is determined by a government act, and declared to be officially recognised payment for all debts, both private and public.
   

Regarding fiat money, consider the US 1914 $1 Bank Note after the introduction of the US Federal Reserve. At the time it was issued, a ‘note’ was well understood to be a promise of payment. And what is this Note redeemable in? Here's what it says: "Secured By United States Certificates Of Indebtedness Or One-Year Gold Notes, Deposited With The Treasurer Of The United States Of America". The Note was directly redeemable in Treasury debt, but it was not directly redeemable in Gold.

Now fast forward to 1963 and the US $1 note simply states: “This Note Is Legal Tender For All Debts Public And Private”.

Fiat money has advantages over commodity money in that it can be ‘replaced’ if the note is lost or damaged, unlike commodity money which is lost for good. Fiat money has several disadvantages though:

• The stability of fiat money is related to the stability of the government system declaring the money into existence. Any failure of the government which issues the legal tender will undermine the value of that money.
• If the declaring government issues more fiat money than available goods and services, then higher prices will likely result (defined as inflationary in some circles). 1920’s Germany or current-day examples of nations experiencing hyper-inflation as a result of excess (fiat) money printing.

Most all modern nations adopt fiat money management by a Federal Reserve banking system.

Wikipedia provides a more detailed summary on the 'History of Money', reproduced here for reader ease:

According to some fables, inventors of money were Demodike (or Hermodike) of Kymi (the wife of Midas), Lykos (son of Pandion II and ancestor of the Lycians) and Erichthonius, the Lydians or the Naxians. However, the use of proto-money may date back to at least 100,000 years ago, and the use of precious metals as money dates back at least 6000 years. The use of gold as money has been traced back to the fourth millennium B.C. when the Egyptians used gold bars of a set weight as a medium of exchange, as the Sumerians had done somewhat earlier with silver bars. Coins or at least minted tokens of a fixed value first appear in the 7th century BC in Greece. The first banknotes was used in China in the 7th century, and the first in Europe was issued by Stockholms Banco in 1661.”

Curious readers can find out more about 'A History of US Paper Money' here with thanks to www.the-privateer.com.

• ‘A History of U.S. Paper Money': http://www.the-privateer.com/paper.html
• Money: http://en.wikipedia.org/wiki/Money

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