MONEY

Anything commonly accepted as a Legal Tender currency for payment of debts. Money
has been defined any number of ways, but it generally serves three distinct purposes,
depending on how it is used: (1) as a medium of exchange for payments between
consumers, businesses, and government; (2) as a unit of account for measuring
purchasing power, or the prices paid for goods and services; and (3) as a store of value
for measuring the economic worth of current income deferred for spending in future
years.

In the United States, paper currency (Federal Reserve Note), coins, and checking account
balances are examples of money. Other forms of money are commodity money (gold and
silver bullion and coins, brightly colored shells and so on), and Barter the trading of
goods and services without monetary exchange. Today, paper currency represents only a
fraction of the nation's money supply; about three-fourths of the Money Supply is held in
the form of bookkeeping debits and credits representing demand deposit (checking)
account balances in commercial banks. See also Currency in Circulation; Fiat Money;
M1; M2; M3; Monetary Base; Money Supply; Near 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. 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.

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. 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 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.

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 is generally considered to have the following characteristics, which are summed
up in a rhyme found in older economics textbooks: "Money is a matter of functions four,
a medium, a measure, a standard, a store." That is, money functions as a medium of
exchange, a unit of account, a standard of deferred payment, and a store of value.[2][5][6]

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. One of these arguments is that the role of money
as a medium of exchange is in conflict with its role as a store of value: its role as a
store of value requires holding it without spending, whereas its role as a medium
of exchange requires it to circulate.[6] Others argue that storing of value is just
deferral of the exchange, but does not diminish the fact that money is a medium of
exchange that can be transported both across space and time.[7] 'Financial capital'
is a more general and inclusive term for all liquid instruments, whether or not they
are a uniformly recognized tender.

Money is used as an intermediary for trade, in order to avoid the inefficiencies of a barter
system, which are sometimes referred to as the 'double coincidence of wants problem'.
Such usage is termed a medium of exchange.

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 prerequisite for the
formulation of commercial agreements that involve debt.
 • Divisible into small units without destroying its value; precious metals can be
coined from bars, or melted down into bars again.
• Fungible: that is, one unit or piece must be perceived as equivalent to any other,
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.

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 store of value.

Liquidity describes how easily an item can be traded for another item, 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 low transaction costs. There
should be no — or minimal — spread between the prices to buy and sell the instrument
being used as money.

In economics, money is a broad term that refers to any financial instrument that can fulfill
the functions of money (detailed above). Modern monetary theory distinguishes among
different types of monetary aggregates, using a categorization system that focuses on the
liquidity of the financial instrument used as money.

Commodity money value comes from the commodity out of which it is made. The
commodity itself constitutes the money, and the money is the commodity.[8] Examples of
commodities that have been used as mediums of exchange include gold, silver, copper,
rice, salt, peppercorns, large stones, decorated belts, shells, alcohol, cigarettes, cannabis,
candy, barley, etc. These items were sometimes used in a metric of perceived value in
conjunction to one another, in various commodity valuation or Price System economies.
Use of commodity money is similar to barter, but a commodity money provides a simple
and automatic unit of account for the commodity which is being used as money.

Representative money

Representative money is money that consists of token coins, other physical tokens such
as certificates, and even non-physical "digital certificates" (authenticated digital
transactions) that can be reliably exchanged for a fixed quantity of a commodity such as
gold, silver or potentially water, oil or food. Representative money thus stands in direct
and fixed relation to the commodity which backs it, while not itself being composed of
that commodity.
Credit money

Credit money is any claim against a physical or legal person that can be used for the
purchase of goods and services.[8] Credit money differs from commodity and fiat money
in two ways: It is not payable on demand (although in the case of fiat money, "demand
payment" is a purely symbolic act since all that can be demanded is other types of fiat
currency) 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.[8]

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 receive
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.[9]

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.

Fiat money

Fiat money is any money whose value is determined by legal means. The terms fiat
currency and fiat money relate to types of currency or money whose usefulness results
not from any intrinsic value or guarantee that it can be converted into gold or another
currency, but instead from a government's order (fiat) that it must be accepted as a means
of payment.[10] [11]
Fiat money is created when a type of credit money (typically notes from a central bank,
such as the Federal Reserve System in the U.S.) is declared by a government act (fiat) to
be acceptable and officially-recognized payment for all debts, both public and private.
Fiat money may thus be symbolic of a commodity or a government promise, though not a
completely specified amount of either of these. Fiat money is thus not technically fungible
or tradable directly for fixed quantities of anything, except more of the same
government's fiat money. Fiat moneys usually trade against each other in value in an
international market, as with other goods. An exception to this is when currencies are
locked to each other, as explained below. Many but not all fiat moneys are accepted on
the international market as having value. Those that are trade indirectly against any
internationally available goods and services [8]. Thus the number of U.S. dollars or
Japanese yen which are equivalent to each other, or to a gram of gold metal, are all
market decisions which change from moment to moment on a daily basis. Occasionally, a
country will peg the value of its fiat money to that of the fiat money of a larger economy:
for example the Belize dollar trades in fixed proportion (at 2:1) to the U.S. dollar, so there
is no floating value ratio of the two currencies.

Fiat money, if physically represented in the form of currency (paper or coins) can be
easily damaged or destroyed. However, here fiat money has an advantage over
representative or 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
U.S. government will replace mutilated federal reserve notes (U.S. fiat money) if at least
half of the physical note can be reconstructed, or if it can be otherwise proven to have
been destroyed.[12] By contrast, commodity money which has been destroyed or lost is
gone.

Money supply

The money supply is the amount of money 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 European Central Bank.
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. This kind of increase in the value of gold helps savers
and creditors and is called deflation, where items for sale are less expensive in terms of
gold. Deflation was the more typical situation for over a century when gold and credit
money backed by gold were used as money in the US from 1792 to 1913.