Money





Money is an intermediary that serves as a medium of exchange, unit of
account, standard of deferred payment and a store of value. Money is one of
the central topics studied in economics. There have been many historical
arguments regarding the combination of these four functions, some arguing
that they need more separation and that a single unit is insufficient to
deal with them all. These arguments are covered in financial capital which
is a more general and inclusive term for all liquid instruments, whether or
not they are a uniformly recognized tender.

Before Money

Prior to the introduction of money, barter was the only way to exchange
goods. Bartering has several problems, most notably timing constraints. If
you wish to trade pigs for wheat, you can only do this when the pigs and
wheat are both available at the same time and place - and without proper
storage that may be a very brief time. With a trade standard like gold, you
can sell your pigs at the "best time" and take the coins. You can then use
that gold to buy wheat when the harvest comes in. Thus the use of money
makes all commodities become more liquid.

Early systems, Commodity Money

The first instances of money were objects which were useful for their
intrinsic value. This was known as commodity money and included any
commonly-available commodity that has intrinsic value; historical examples
include pigs, rare seashells, whale's teeth, and (often) cattle.

Even in the industrialised world, in absence of other types of money, people
have occasionally used commodities like tobacco as money. This last happened
last on a wide scale after World War II when cigarettes became used
unofficially in Europe, in parallel with other currencies, for a short time.

Another example of "commodity money" is shell money in the Solomon Islands.
Shells are painstakingly chipped into rough circles, filed down, and
threaded onto large necklaces, which are then used during marriage
proposals; for instance, a father may charge twenty shell money necklaces
for his daughter's hand in marriage.

Once a commodity becomes used as money, it takes on a value that is often a
bit different from what the commodity is intrinsically worth or useful for.
Being able to use something as money in a society adds an extra use to it,
and so adds value to it. This extra use is a convention of society, and how
extensive the use of money is within the society will affect the value of
the monetary commodity. So although commodity money is real, it should not
be seen as having a fixed value in absolute terms. Its value is still
socially determined to a large extent. A prime example is gold, which has
been valued differently by many different societies, but perhaps none valued
it more than those who used it as money. Fluctuations in the value of
commodity money can be strongly influenced by supply and demand whether
current or predicted (i.e. if you know the local gold mine is about to run
out of ore, the price of gold will go up in anticipation of a shortage).

Money can be anything that the parties agree is tradable, but the usability
of a particular sort of money varies widely. Desirable features of a good
basis for money include being able to be stored for long periods of time,
dense so it can be carried around easily, and difficult to find on its own
so that it is actually worth something. Again, supply and demand play a key
role in determining value. When governments print more banknotes, they are
increasing the supply of money without any underlying increase in value.
Therefore, the money becomes worth less than before the new banknotes were issued.

For these reasons metals like gold and silver have often been used for a
commodity money. However these metals are also easily alloyed with a less
expensive metal, making their value somewhat suspect.

Standardized Coinage

It was the discovery of the touchstone that paved the way for metal-based
commodity money and coinage. Any soft metal can be tested for purity on a
touchstone, allowing one to quickly calculate the total content of a
particular metal in a lump. Gold is a soft metal, which is also hard to come
by, dense, and storable. For these reasons gold as a money spread very
quickly from Asia Minor where it first gained wide use, to the entire world.

Using such a system still required several steps and some math. The
touchstone allowed you to estimate the amount of gold in an alloy, which was
then multiplied by the weight to find the amount of gold alone in a lump.

To make this process easier, the concept of standard coinage was introduced.
Coins were pre-weighed and pre-alloyed, so as long as you were aware of the
origin of the coin, no use of the touchstone was required. Coins were
typically minted by governments in a carefully protected process, and then
stamped with an emblem that guaranteed the weight and value of the metal.

Although gold and silver were commonly used to mint coins, other metals
could be used -- in the early seventeenth century Sweden lacked more
precious metal and so produced "plate money" which were large slabs of
copper approximately 50cm or more in length and width, appropriately stamped
with indications of their value. The unwieldiness of this plate money no
doubt contributed to Sweden becoming the first European country to issue
paper currency, in 1661.

Representative Money

The system of commodity money in many instances evolved into a system of
representative money. In this system, the money itself had no intrinsic
value, but could be converted into commodities with intrinsic values.

Paper currency and non-precious coinage was backed by a government or bank's
promise to redeem it for a given weight of precious metal, such as silver.
This is the origin of the term "British Pound" for instance, it was a unit
of money backed by a pound of sterling silver - hence the currency Pound
Sterling.

For much of the nineteenth and twenieth centuries, many currencies were
based on representative money through the use of the gold standard.

Fiat Money

Fiat money refers to money that is not backed by reserves of another
commodity. The money itself is given value due to an authority such as a
government acting like it has value. If a large enough organisation issues,
uses, and accepts something as payment for bills or taxes, that in itself
gives the money some value because certain payments can be made with it.
Perhaps the value it has is not the same as the large organisation might
like, but there is some value nevertheless.

Governments through history have often switched to forms of fiat money in
times of need such as war, sometimes by suspending the service they provided
of exchanging their money for gold, and other times by simply printing the
money that they needed. It was seen over time that suspending the exchange
of a currency for gold (or whatever the currency represented) had less
effect on what could be bought with it than many people expected.
Occasionally, governments also by simple decree changed the amount of gold
they would supply in exchange for their notes, and this also often had less
effect on what could be bought with the money than the change in the amount
of gold should have implied.

In 1971 the US finally switched to fiat money indefinitely. At this point in
time many of the economically developed country's currencies were fixed to
the US dollar, and so this single step meant that much of the western
world's currencies became fiat money based.

Credit Money

Credit money often exists in parallel with other money such as fiat money or
commodity money, and from the users point of view is indistinguishable from
it. Most of the western world's money is credit money derived from national
fiat money currencies. Credit money tends to arise as a byproduct of lending
and borrowing money. The following example illustrates this.

Imagine you have deposited some gold coins in a bank vault. The bank might
lend the coins to a second person based on a promise to pay equivalent coins
back with a few extra at a time in the future. The second person can in the
meantime use the coins normally as money. But you still own the coins, and
you also could still use them - you could transfer their ownership to
another person to pay for something you have bought by telling the bank to
transfer them from your account to the other persons. You might do this by
writing a check. So in this simple example there are two people using the
same coins as money at the same time. It's as if new money has been created
by the act of lending. Taking it another step, if the second person spends
the coins at a shop, and they end up being deposited back into the bank by
the shopkeeper, the bank can lend them again. Now you and the shopkeeper can
use the coins in the same way, by writing checks or the equivalent in this
example, and whoever borrows the coins a second time can use the coins
directly as money. So there are three people with financial use of the
coins. This can go on with many people ending up simultaneously using the
same coins financially, but for each extra user there is a promise to pay
equivalent coins back. These arrangements where many people use the same
money simultaneously is in many respects the same as if there was extra
money. The extra money that there appears to be is known as credit money. It
is in the controling the amount of money a bank can lend that the Federal
Reserve can set the money supply and change Fiscal policy The credible
promises to repay in a reasonable time give the extra money its value. It
tends to exist in parallel with another form of money such as fiat money or
commodity money, wherever banking style loans are used, and occurs as a
byproduct of lending. It could occur without banks, but banks provide a
degree of stability to the whole process by taking and evaluating the risk
involved in each loan.

During the Crusades in Europe, precious goods would be entrusted to the
Catholic Church's Knights Templar, who effectively created a system of
modern credit accounts. Over time this system grew into the credit money
that we know today, where banks create money by approving loans - although
the risk and reserve policies of each national central bank sets a limit on
this, requiring banks to keep reserves of fiat money to back their deposits.
Sometimes, as in the U.S.A. during the Great Depression or the Savings and
Loan Scandal, trust in bank policies drops very low and government must
intervene to keep the industry of credit in operation.