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What is Money?

By Edited Jul 1, 2016 0 0

Through the ages, humans have battled over money— both to plunder the treasures and wealth of their foes or victims, and to acquire monetary wealth as a premiere form of power and influence. With money, kings raise armies, build castles and cities, and strive for dominion over both their own realms, and the realms of others. But on the smaller and more benign scale, money is the great liberator of the individual to do as he or she pleases. Often, the more money an individual possesses, the more freedom and opportunity that person can enjoy. Even those whose professed ideological precepts prompt them to castigate or demonize monetary wealth in their public speech are often greatly concerned with acquiring as much of it as possible, in practice.

But what is money?  Different camps of theoretical economists usually cannot agree on a single broadened definition, but most dictionaries define it as "a current medium of exchange in the form of coins and banknotes."

Chocolate Gold Coins
Really, virtually anything that is accepted as a medium of exchange can serve as a form of money. History provides a wealth of examples of unusual forms of commodity money that have been used in the past (and in some cases still are used as money today), from cattle, gold, grains, salt, whale's teeth, beast-skins, dried fish, to iron snakes or giant stone wheels. 

In slightly wider terms, money can be anything widely used for making payments and accounting for debts and credits.  Such a "unit of account" could be any simple tool to add or subtract perceived value and account for debts owed, such as a mark on a tally stick, a clay token, or—more familiarly—coins denominated according to a given standard of weights and measures.

Whenever any form of money is used a medium of exchange, each party involved in the transaction must perceive some value in the unit of money being exchanged. Even if they have no use for the item itself (whether it's a paper bill, a gold coin, a cowry shell, or a whale's tooth), they must see the money as at least having perceived value, so that they can exchange it for something that they do value in the future. Here the importance of money serving as a satisfactory "store of value" becomes clearer: An ideal form of money should not only be exchangeable and capable of serving as a unit of account, it should also store its value over time. If the money in currently in use is such a poor store of value that it actually loses its value consistently over time, then those who wish to save and conserve their wealth will be obliged to continually convert their money into some other form of asset that will hold its value— or else face losses.

The Qualities of an Ideal Form of Money 

An ideal form of money can arguably be said to have the following qualities: 

The money is useful as a convenient medium of exchange & means of payment. Gold and silver coins have always fulfilled these functions well.

Bank Notes
So have paper bills— but only when considered purely in terms of convenience as a medium of exchange, and not as a long-term store of value!

The money is an easily understood measure of value & unit of account. Money should ideally be convenient for pricing goods and services of all types, subject to negotiations in the markets. For example, at a given time, the price of a bottle of vintage wine might be expressed as 2 grams of gold, while the price of a new home might be expressed as several hundred troy ounces of gold. In each case, the money provides a useful tool for measuring value, and making the relative prices of countless disparate goods and services easy to understand. The same thing is usually true of the national currencies with which most of us are already thoroughly familiar.

Without the use of money as a common measure of value, transactions would have to be arranged using a bewilderingly large number of prices, expressed in each case as exchange rates between each good or service in question.

Unit of Account
E.g., the price of fish denominated in loaves of bread, the price of groats denominated in turnips, the price of vintage wine denominated in hours of labor expended on accounting services, etc. 

Money as a unit of account is also indispensable to keep track of debts. In the case of debts, increases or decreases in the value of money's purchasing power can either benefit or harm debtors— and vice versa for creditors. This leads to the next ideal quality of money: a store of value.  

Ideal money is a good "store of value" — i.e. something which holds its value over time. This, of course, requires that the money do reasonably well at maintaining its value in terms of its purchasing power— not merely that it physically endure over time, as with common stones.

Russian Gold
Over the long course of time, gold and silver have generally been excellent long-term stores of value (though certainly not always in the short-term). Many of the perishable objects that were often used as ancient commodity money were obviously serviceable only for reasonably short-term periods, not for hoarding or for long-term savings. Pure fiat currencies (i.e. money that is decreed legal tender by government edict, but is intrinsically worthless) such as paper bills have almost always done notoriously poorly as long-term stores of value, regardless of how prestigious the currencies are imagined to be at any particular period in time.

Money's Value & The Role of Credit

Money's role as a store of value becomes all the more interesting when considering its relationship to credit— the amount of money available to an individual, business, or government to borrow. Debtors with contracts that stipulate fixed principal and interest payments can often benefit when their debts are denominated in a depreciating currency–i.e., a form of money that is losing its purchasing power over time. This is because each unit of money that the debtor is obligated to repay in the future is going to be worth less and less (in terms of its ability to purchase real goods or services) as time goes by. This is often true for both individuals and for governments, and is one of many reasons why heavily indebted governments are frequently suspected of following monetary policies that consistently weaken their national currencies. 

Money to Burn
In theory, creditors can benefit from just the opposite situation: If the money is appreciating in value (i.e. when each unit of money can be used to purchase more real goods and services as time progresses), then the same fixed payments that a creditor's customers owe to them are going to be worth progressively more as time goes by— unless this situation causes the debtors to default on their loans! The latter scenario was likely what the American industrialist J. Paul Getty had in mind when he made the remark that: "If you owe the bank $100 that's your problem. If you owe the bank $100 million, that's the bank's problem."


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