All About Money

The last couple of days I’ve been watching the sort of movies that challenged me to think about money theoretically.So to brush up on stuff I last had to deal with some 15 years ago I’ve been surfing the net for the sort of stuff found in basic economics books.In case you too need a small revision or you are totally new to economics here’s a chance to catch up.

BTW I’ve tried to make the whole experience as un lecture like as I can.Enjoy!

Definition : What is Money?

Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context.

Examples of Money:Cowrie shells,beads,metal coins,paper money,electronic money etc.

Since money involves so many things it is identified by the functions it performs.Any kind of object or secure verifiable record that fulfills these functions can serve as money.

Functions of Money

And here is a ditty to remember the functions of money:

“Money is a matter of functions four, a medium, a measure, a standard, a store.”

The main functions of money are distinguished as:

(1) a medium of exchange

When money is used to intermediate the exchange of goods and services, it is performing a function as a medium of exchange.Without money society will have to depend on gifting and barter.

(2)a unit of account

A unit of account or “measure” or “standard” of relative worth is a standard numerical unit of measurement of the market value of goods, services, and other transactions. To function as a ‘unit of account’, whatever is being used as money must be:

  • Divisible into smaller units without loss of 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 whydiamonds, 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 milled with a reeded edge, so that any removal of material from the coin (lowering its commodity value) will be easy to detect.

(3)a standard of deferred payment

A “standard of deferred payment” is an accepted way to settle a debt – a unit in which debts are denominated, and the status of money as legal tender, in those jurisdictions which have this concept, states that it may function for the discharge of debts. When debts are denominated in money, the real value of debts may change due to inflation and deflation, and for sovereign and international debts via debasement and devaluation.

(4)a store of value

To act as a store of value, money must be able to be reliably saved, stored, and retrieved – and be predictably usable as a medium of exchange when it is retrieved. The value of the money must also remain stable over time. Inflation by reducing the value of money, diminishes the ability of the money to function as a store of value.

If you’d rather watch a video,the above is summarized here:

Money supply

In economics, money is a broad term that refers to any financial instrument that can fulfill the functions of money (detailed above). These financial instruments together are collectively referred to as the money supply of an economy.(NB:Currency refers to coins and bank notes only)

In India the Reserve Bank of India defines the monetary aggregates as:

  • Reserve Money (M0): Currency in circulation + Bankers’ deposits with the RBI + ‘Other’ deposits with the RBI = Net RBI credit to the Government + RBI credit to the commercial sector + RBI’s claims on banks + RBI’s net foreign assets + Government’s currency liabilities to the public – RBI’s net non-monetary liabilities.
  • M1: Currency with the public + Deposit money of the public (Demand deposits with the banking system + ‘Other’ deposits with the RBI).
  • M2: M1 + Savings deposits with Post office savings banks.
  • M3: M1+ Time deposits with the banking system = Net bank credit to the Government + Bank credit to the commercial sector + Net foreign exchange assets of the banking sector + Government’s currency liabilities to the public – Net non-monetary liabilities of the banking sector (Other than Time Deposits).
  • M4: M3 + All deposits with post office savings banks (excluding National Savings Certificates).

Types of money
1.Commodity 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. 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, 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. Although some gold coins such as the Krugerrand are considered legal tender, there is no record of their face value on either side of the coin. The rationale for this is that emphasis is laid on their direct link to the prevailing value of their fine gold content

2.Representative Money

Money that consists of token coins or other physical tokens such as certificates that can be reliably exchanged for a fixed quantity of a commodity such as gold or silver. The value of representative money stands in direct and fixed relation to the commodity that backs it, while not itself being composed of that commodity.

3.Fiat Money

Fiat money or fiat currency is money whose value is not derived from any intrinsic value or guarantee that it can be converted into a valuable commodity (such as gold). Instead, it has value only by government order (fiat). Usually, the government declares the fiat currency (typically notes and coins from a central bank) to be legal tender, making it unlawful to not accept the fiat currency as a means of repayment for all debts, public and private.

Fiat money, despite all the criticism today,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, governments will replace mutilated notes if  it can be proven that they have been destroyed. By contrast, commodity money which has been lost or destroyed cannot be recovered.



About Keerthika Singaravel

3 Responses to All About Money

  1. Pingback: My Thoughts | wealthymatters

  2. Ball says:

    Heya! Thank you for this brilliant blog post – ‘All About Moneey’ Wealthymatters.

  3. Mike says:

    Great Post

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