Money



Economics offers various definitions for money, though it is now commonly defined by the functions attached to any good or token that functions in trade as a medium of exchange, store of value, and unit of account. Some authors explicitly require money to be a standard of deferred payment, too. 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. Other older functions a money may possess are a means of rationing access to scarce resources, and a means of accumulating power of command over others.

The use of money provides an alternative to bartering, which is often considered 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.

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
* cowries were used as a money in 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 have functioned as currency since the reign of Croesus of Lydia, if not before.
* rum-currency operated in the early European settlement of Sydney cove in Australia.

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 even if inflation damages their value as currency, 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[citation needed]. It quickly begins functioning as a store of value, since holders of perishable goods can easily convert them into durable money.

Fiat money is a relatively modern invention. A central authority (government) creates a new money object that has negligible inherent value. The widespread acceptance of fiat money is most frequently enhanced by the central authority mandating the money's acceptance under penalty of law and demanding this money in payment of taxes or tribute. At various times in history, government-issued promissory notes have later become fiat currencies (e.g. the US Dollar) and fiat currencies have gone on to become a form of commodity currency (e.g. the Swiss Dinar).

In many languages, the word for money is the same as or similar to the word for silver or gold. The French use the word argent, which means 'silver', to mean money 1. In Hebrew, the word kesepph means both 'silver' and 'money' 2.

Money has developed over the years from gold, silver, copper, brass, iron, stones, or shells to paper, or electronic entries being managed by complex international banking systems.

Money is generally considered to have the following three characteristics:

1. It is a medium of exchange

A medium of exchange is an intermediary used in trade to avoid the inconveniences of a pure barter system.

2. It is a unit of account

A unit of account is a standard numerical unit of measurement of the market value of goods, services, and other transactions.

3. It is a 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.

To function as money, the monetary item should possess a number of features:

To be a medium of exchange:

* It should have liquidity, and be easily tradable, with a low spread between the prices to buy and sell, in other words, a low transaction cost.
* 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. The Mexican 20 peso note is made of plastic for 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. Unlike paper, silver, as well as platinum and titanium, is used as a anti-bacterial and anti-viral agent. This property of silver has been recognised for millennia and used for eating utensils.

To be a unit of account:

* It 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, or live animals are not suitable as money.
* It should be 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.
* It must be 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 be a store of value:

* It should be long lasting, 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.

To be anonymous:

* Money should not be subject to government tracking.
* It should be useable for purchases in a black market.
* It should not require equipment, tools or electricity to use.

Money also is typically that which has the least declining marginal utility, meaning that as you accumulate more units of it, each unit is worth about the same as the prior units, and not substantially less.

For these reasons, gold and silver have been chosen again and again throughout history as money in more societies and in more cultures and over longer time periods than any other items. Platinum and palladium have not been identified and refined until the last two hundred years, and do not therefore have a long history of use as money, but that may change in the future.

One key benefit of these features of money is that it facilitates and encourages trade, as barter is far less efficient.

There is no perfect money, although gold may come closest to this standard. Gold is not always the most liquid asset, as it does have a spread of about 4% to buy and sell, whereas paper money can be exchanged for much less. Furthermore, gold today is a relatively small market, and the price of gold can move substantially higher if a few billion dollars tries to buy gold. Although gold itself does not decay, gold coins are easily scratched or damaged, and this can reduce their value, and reduce the fungibility or exchangeability of gold coins. Gold coins are often made with 10% copper for added durability, such as the Krugerrand and the U.S. Eagle, but then the gold is no longer 99.9% pure, or .999 fine. From 1980 to 2001, gold was a poor store of value as its own value was unstable; gold prices dropped from a high of $850/oz. to a low of $255/oz., and that is also being measured in terms of dollars that were also losing value, so the 1980 high might be more like $1600/oz., but a precisely accurate amount is nearly impossible to measure. Money is supposed to be an honest weight and measure, but one cannot easily measure the changing value of gold by dollars, which likewise change in value.

Additionally, Gresham's Law indicates that "bad money" always wipes "good money" out of circulation. For example, if an ordinary gas cylinder in a market is sold below its manufacturing costs, people will automatically try to sell the cylinders in favor of an item which is easier to turn over. Eventually, all the cylinders will disappear from the market. One can therefore claim the same problem with gold as a means of exchange.

Due to the ease of production paper money may lose value through inflation and can be easily damaged or destroyed. Despite the ease of production there have been notable instances paper money experiencing deflation. For example the British Pound after the 1925 revision of the gold standard and the Japanese Yen during the 1990s. Perhaps the biggest criticism of paper money relates to the fact that its stability is generally subject the whim of government regulation rather than the disciplines of market phenoma.

Banknotes (also known as paper money) and coins are the most liquid forms of tangible money and are commonly used for small person-to-person transactions. 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.

There are also less tangible forms of money, which nevertheless serve the same functions as money. Checks, 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.

Credit is often loosely referred to as money. Credit is debt or a promise to settle a debt, not money. Money is what is used to make a payment in full.

This distinction between money and credit causes much confusion in discussions of monetary theory. In lay terms, and when convenient in academic discussion, credit and money are frequently used interchangeably. For example, bank deposits are generally included in summations of the national broad money supply. However, any detailed study of monetary theory needs to recognize the proper distinction between money and credit.

Bank notes are a form of credit. Gold-backed bills are likewise also a debt of the bank, a promise to pay in gold.

Federal Reserve notes, which are used as money in the United States, are difficult to describe in terms of credit or debt or money. Federal Reserve notes are not a promise to pay in gold, and the notes are irredeemable by the issuer. The Federal Reserve's notes are perhaps viewed best as a political promise to devalue (inflate) at a certain targeted rate.

Since Federal Reserve notes are used in the United States as the most common medium of exchange, unit of account, and store of value, they are considered money by the majority of the population. To measure this kind of credit money, various forms of credit are counted together and listed as M1 or M2. M3 was the most common measure of money, but the publication of M3 was discontinued in May, 2006.

Money is one of the most central topics studied in economics and forms its most cogent link to finance. Monetarism is an economic theory which predominantly deals with the supply and demand for money. The stability of the demand for money prior to the 1980s was a key finding of the work of Milton Friedman, Anna Schwartz, David Laidler, and many others. Technical, institutional, and legal changes changed the nature of the demand for money during the 1980s.

Monetary policy aims to manage the money supply, inflation and interest to affect output and employment. Inflation is the decrease in the value of a specific currency over time and can be caused by dramatic increases in the money supply. The interest rate, the cost of borrowing money, is an important tool used to control inflation and economic growth in monetary economics. Central banks are often made responsible for monitoring and controlling the money supply, interest rates and banking.

A monetary crisis can have very significant economic effects, particularly if it leads to monetary failure and the adoption of a much less efficient barter economy. This happened in Russia, for instance, after the fall of the Soviet Union.

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.

In many countries, the issue of private paper currencies has been severely restricted by law.

In the United States, the Free Banking Era lasted between 1837 and 1866. States, municipalities, private banks, railroad and construction companies, stores, restaurants, churches and individuals printed an estimated 8,000 different monies by 1860. If the issuer went bankrupt, closed, left town, or otherwise went out of business the note would be worthless. Such organizations earned the nickname of "wildcat banks" for a reputation of unreliability and that they were often situated in far-off, unpopulated locales that were said to be more apt to wildcats than people. On the other hand, according to Lawrence H. White's article in The Freeman: Ideas on Liberty - October 1993 "it turns out that “wildcat” banking is largely a myth. Although stories about crooked banking practices are entertaining—and for that reason have been repeated endlessly by textbooks—modern economic historians have found that there were in fact very few banks that fit any reasonable definition of wildcat bank." The National Bank Act of 1863 ended the "wildcat bank" period.

In Australia, the Bank Notes Tax Act of 1910 basically shut down the circulation of private currencies by imposing a prohibitive tax on the practice. Many other nations have similar such policies that eliminate private sector competition.

In Scotland and Northern Ireland private sector banks are licensed to print their own paper money by the government. Today privately issued electronic money is in circulation. Some of these private currencies are backed by historic forms of money such as gold, as in the case of digital gold currency. Transactions in these currencies represent an annual turnover value in billions of US dollars.

It is possible for privately issued money to be backed by any other material, although some people argue about perishable materials. After all, gold, or platinum, or silver, have in some regards less utility than previously (their electrical properties notwithstanding), while currency backed by energy (measured in joules) or by transport (measured in kilogramme*kilometre/hour) or by food is also possible and may be accepted by the people, if legalised. It is important to understand though that, as long as money is above all an agreement to use something as a medium of exchange, it is up to a community (or to whoever holds the power within a community) to decide whether money should be backed by whatever material or should be totally virtual.

Paper money's greatest failure is as a stable store of value. All paper money is plagued by inflation, the devaluation of money over time. Although inflation may be good for debtors, it is not good for savers.

Investors seek to preserve or grow their wealth, and some seek to buy currencies that will stay strong and keep their value. In 2006, the currency markets trade over $1 trillion each day. In 2006, all the gold in all the world is valued at about $3.5 trillion.

Today, gold can be traded electronically via online systems.

The money supply is the amount of money available within a specific economy available for purchasing goods or services. The supply 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 United States, 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 greater 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 U.S. from 1792 to 1913.Permission is granted to copy, distribute and/or modify this document under the terms of the GNU Free Documentation License, Version 1.2 or any later version published by the Free Software Foundation; with no Invariant Sections, with no Front-Cover Texts, and with no Back-Cover Texts.
Virtual Magic is a human knowledge database blog. Text Based On Information From Wikipedia, Under The GNU Free Documentation License. Copyright (c) 2007 Virtual Magic. Permission is granted to copy, distribute and/or modify this document under the terms of the GNU Free Documentation License, Version 1.1 or any later version published by the Free Software Foundation; with no Invariant Sections, no Front-Cover Texts and no Back-Cover Texts. A copy of the license is included in the section entitled "GNU Free Documentation License".

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