Money

What Is Money?

Money is a commodity that acts as a form of payment accepted universally.

In economics, a commodity is a good, usually a resource, that is entirely fungible. It can be replaced with any other unit of the same good and provide the same use. 

This may seem odd, but would you be upset if someone took a dollar and gave you a different one? Of course, you can still take that dollar anywhere and spend it as you wish. 

This is merely one of the characteristics of legal tender that you might take for granted daily. 

From dollars to pesos to yuan, there are common traits, functions, and measurement systems that all currencies follow, all of which will be covered. 

An analysis of the history and present state of currency will also be done to increase our understanding of cash and how it may evolve in the future. 

history Of Money

To understand how we have reached the current state of currency and trade, one must look back through history at how it has evolved to fulfill the needs of society. 

We have moved from wandering nomads hunting for survival to a sedentary farming life. From that, empires were built, and wars were fought for supremacy. Then, banks and mints were formed, and now we can purchase a house with a piece of plastic.

To reach this stage of currency, radical changes have occurred. 

We’ll look at how society shifted from nothing to a weighing system, to small coins pressed with stamps, to paper currency, and lastly to banks, credit cards, and digital transactions. 

Cash is intertwined into everyone’s daily lives and is a powerful reflection of a society and its priorities. 

First, we’ll look at when and why it was necessary and how forty went without any true form of a common currency.

Types Of Money

While there are many types of currency, as we've previously covered, every single kind can be divided into two distinct categories:

1. Hard: This kind of currency requires some item with inherent value to be based upon.
2. Fiat: This currency is based on nothing, essentially only holding value because a government or group of people agree it does. It is generally declared to be legal tender to attain value. 

Hard money has been standard for the majority of history. 

Coins made of precious metals and mono and bimetallic standards allowed currencies to have an intrinsic value equal to the value of the cash itself. 

Fiat money has only recently become the more popular of the two. However, this is the first time in history that every nation has issued and accepted fiat currency alone. 

While debates continue to rage on about the long-term viability of fiat currencies, it appears there won't be a great reversal back to hard currency soon. 

Characteristics and Functions of Money

Another hotly debated topic is the traits needed for a currency to be widely accepted. 

This list of requirements, however, includes almost every point talked about:

1. Divisible: The basic unit of a currency has to be divided into smaller units to allow for smaller or larger purchases
2. Portable: It must be simple and easy to carry around for purchases
3. Limited supply: The amount of currency in circulation must be limited
4. Durable: The currency must be able to maintain shape and utility through average cases of use
5. Uniform: Equal units must have equal values
6. Acceptable: It must be accepted as payment everywhere
7. Fungible: Each unit must be interchangeable 
8. Recognizable: Authenticity and quantity must be easy to see
9. Stable: The value of one unit must be relatively stable

If all of these characteristics are fulfilled, a currency should be able to provide all the functions society currently demands of it. The functions are:

1. Store of value: The ability to save, store, and then spend it for the same approximate value
2. Unit of account: Used to assign prices to goods and services, as a measurement for debt agreements, and calculations like accounting.
3. Medium of exchange: Accepted as a form of payment 

The first function is for people to take currency gained in a transaction and confidently keep it for long periods to spend later. 

The confidence in a dollar to maintain some value at any time encourages people to constantly acquire more rather than only keeping small amounts in fear of a large crash. 

The second function is pivotal for things like accounting, involving comparing assets and liabilities, which would be near impossible without a measurement system. 

It also creates a simple system for pricing. For example, one apple may cost one dollar, while an orange costs two. 

You could price an orange as two apples, but that requires what is called a "coincidence of wants," in which each party has something the other party wants—a vital issue with the bartering system. 

Currency allows Orange to cost two dollars and a purchaser to get those two dollars from any previous transaction. 

The third function is probably the most simple, allowing people to offer currency as a form of payment for a good or service.

Business before money

Approximately 8,000 years ago, in 6000 BC, in what is now Iraq, Iran, Syria, and Turkey, Mesopotamian tribes began using a rudimentary bartering system.

Person A, looking for a good or service, would search out Person B, someone able to provide said goods or services. Once Person B is found, a deal is made. 

Person A offers goods or services in exchange for receiving what is wanted from Person B. Once terms are agreed upon, goods and services are exchanged, and the trade is completed. 

Goods traded included livestock (goats, sheep, camels, etc.), different grains, and leather goods. 

The early Mesopotamian tribes are considered to be the beginning of trade in human civilization.

During the early days of trade in Mesopotamia, Phoenicians, those occupying present-day Syria, Lebanon, and Israel, likely saw this behavior and copied it. Barter began to spread. 

As civilization continued to evolve, trade methods had to evolve as well. 

Simply trading goods and services lacked utility as trading started to move out of small villages and onto a larger scale. 

What was the first currency?

Mesopotamia gained a reputation as more and more trade happened in the area. Egyptians and Indians began trading with the Mesopotamians.

As a more diverse array of people participated in trade, other forms of ‘currency’, such as gold, ivory, pearls, etc., came into circulation. 

To facilitate trade with people like traveling merchants, the currency became necessary. 

This led to the creation of the Mesopotamian shekel nearly 5,000 years ago, in 3000 BCE. The shekel was essentially a weight system for precious metals, semi-precious metals, and barley, rather than what we would consider a currency with a mint. 

The largest unit, called talent or a load, weighed 66 lbs (30 kg). This amount was chosen as it was generally considered the weight one worker could lift. 

It was, however, a difficult way to trade on a smaller scale. Just like a dollar is broken into cents and a pound is broken down into pence, a load must also be broken down. 

The mina was created to be 1/60th of a load, making 60 minas one load. Each mina weighed around 500 grams. 

Worth less than that was the shekel. One shekel weighed about 8.3 grams, meaning that 60 shekels made up approximately one mina. 

Even further division of the shekel was necessary, so the little shekel, 1/60th of a normal shekel, was also created. 

The last and smallest form of currency was called a barleycorn, a grain worth 1/2 of a little shekel or 1/180th of a shekel. 

This system was used and adapted to many different regions as time progressed, with the names and weights differing slightly. 

One example of a variation on this system was the cowrie shells found around 3,000 years ago in China. 

Shells were counted rather than weighed, with one unit being peng, worth two groups of 10 shells. 

The creation of coins and paper currency

China was the very first society to create coins. 

Starting at around 1000 BCE, bronze coins began getting minted for trade. Some of these coins were called bronze shells, referencing previously used cowry shells. 

The circular bronze, copper, tin, or lead coins had a distinct square hole in the middle. Chinese characters were pressed into the coin around the outside of the square.

As the dynasties in power changed frequently, so did coins. Each major dynasty minted its slightly altered coin featuring different text, material, and size. 

This coin system spread in popularity, with ancient Greeks minting their coins featuring various gods, animals, and shapes. 

These coin systems brought huge wealth to the areas that instituted them due to the increased trading that would occur internally and externally afterward. 

Yet again, the Chinese were at the forefront of trading tools. Around 700 CE, the Chinese economy added paper currency alongside coins. Most of the paper currency was used as records of credit as well as for privately used currencies. 

This, again, was later adopted by the rest of the world. 

Ultimately, printing reached a high, causing extreme inflation. This led to the eradication of paper currency in China in 1455, only returning to China hundreds of years later.

Banks

The first banks began in around 2000 BCE. Assyria, Sumeria (ancient Mesopotamian civilizations), and India were the first. 

Religious temples, surprisingly, were the ones to start the banking system. Their main purposes were to store wealth due to their perceived safety and to provide loans.

Specifically, grain loans were given to farmers, who could repay after the next harvest, and traders, who repaid their debts after selling their goods. 

Like the others mentioned, this milestone led to economic growth due to the trading and farming facilitated by loans. 

The system was later integrated into the Greek and Roman economies. 

The Swedish Riksbank was the first central bank, which opened in 1668. 

Riksbank’s goal was to provide government loans and act as an intermediary in the exchange of payments and securities. 

Later, central banks would also aid in controlling the supply of legal tender, interest rates, etc.

Currency wars

With currencies becoming standard across nations and global trade expanding, the exchange of currencies has become the battleground for an invisible war. 

A decrease in the value of a nation's currency, also known as inflation, can be catastrophic for the public in extreme cases. 

Nations, however, have moved to take advantage of this phenomenon. 

Say a nation's government chooses to decrease the value of its currency. They're successful, and their currency loses value in relation to other currencies. 

While this may seem odd, economic benefits can be reaped from this process. The nation's goods become cheaper for foreign countries, driving foreign demand and expanding the economy. 

Investment from foreigners also grows as companies become cheaper, causing further expansion. 

This act, however, does harm to the nation's inhabitants. Purchasing power lessens, and imports become more expensive. 

In the ideal case of a currency war, the pros outweigh the cons. 

Overall, the nation gains an edge in international trade. 

One major example of this was Britain, France, and the United States during the Great Depression. 

Earlier forms of currency warfare were waged for different reasons. Before globalization, devaluing a nation's currency was done by reducing its value by, for example, decreasing the amount of gold in a coin. 

The purpose of this was to increase the supply of legal tender or to increase the wealth of the heads of a nation by decreasing the cost of making more currency. 

The gold standard

A silver or gold standard or both have been maintained throughout history through the materials in the currency itself. For example, a coin was worth the metal it was made of, such as silver.

This system dates back to the Roman Empire. Later, the system evolved into bimetallism. 

Bimetallism is a form of monetary standard. The value of one unit of currency can be traded for a specific amount of gold and a specific amount of silver, for example, with the metals changing but those being the most common. 

This leads to a fixed exchange rate among the three, creating stability. 

It also allowed for a larger currency supply compared to monometallism, a monetary standard using one metal, silver, and gold standard as examples. 

Bimetallism was common, causing issues with a lack of equivalence in exchange rates between countries. 

In 1717, England became the first to employ the gold standard, equating 21 shillings to a gold guinea, or around 7.7g of gold. 

In 1873, the French franc, German mark, and U.S. dollar were all put on the gold standard. 

The switch to the gold standard, along with the enormous amount of silver found in the United States, led to a rapid decrease in the value of silver, pushing more nations to follow in the previous countries' footsteps. 

To finance World War I, many countries abandoned the gold standard, printing more currency and selling off their gold reserves, with Germany and England among the countries ending the policy. 

The United States ultimately ended the gold standard in 1971 when Nixon released an executive order to no longer convert dollars to gold. 

The final country to end the gold standard was Switzerland in 1999, which maintained the standard due to its large gold reserves. 

The current state of money

We have covered a brief history, from a lack of it to the first currency and its weight system, to the very first coin and paper currencies, to the creation of banks, to wars waged through currency, and finally to the gold standard. 

Technological developments and our understanding of economics have led us to the present state of the currency. 

Before we finally reach what some people believe is the future of money as we know it, we have to look at it now.  

The recent changes in legal tender affecting the everyday public and ideas applicable to economics will be reviewed. 

Plastic cards and digital transactions lead to huge increases in debt and ease of purchase. 

Types, characteristics, and measurements of legal tender help define how it works in our economy. 

While looking through this section, see if you notice any similarities between the past and present currency.

Cards and digital transactions

Plastic cards have become a popular form of currency. 

They come in two forms, the first being debit cards. These cards are pre-loaded with the balance in a bank account and withdrawn directly from the account when purchases are made. 

The second type is credit cards. Credit cards are an entirely different beast, allowing you to spend money that's not yours. 

Instead, the card issuer supplies the funds, lent, with the expectation of repayment with interest. 

Credit and debit cards combined were used in 70% of payments in the United States. This helps to show the stark decrease in cash use, making up only 11% of payments. 

Credit and debit cards have made it easy to make payments online and have played a huge role in the creation of the eCommerce industry. 

While the ease of using a credit card is touted frequently, the debt these tools create can ruin people. Credit card debt has increased steadily almost every single year since 1986.

Similar to debit cards, digital wallets are becoming increasingly popular, allowing you to store funds and make payments with mobile devices. 

Apple Wallet and Google Wallet are prime examples of this technology. Increasing in popularity, the use of digital wallets increased almost 4-fold between 2017 and 2021. 

Digital wallets, while seemingly small, were used just as much as cash in 2021.

Measurements Of Money

For economists to see how much of a currency is in circulation in an economy, it must be measured.

While this may seem like a simple issue requiring only a single number, what about the cash in bank accounts? What about cheques? What about assets in the stock market? 

These measurements come into play, allowing us to have different statistics, including currency, in many different forms. 

Some of these measurements are used more than others, and definitions of what they include vary significantly. These definitions are the simplest, excluding some of the more complicated aspects:

• M0: This accounts only for material currency, i.e., the sum of bills and coins in circulation
• M1: Includes M0 and checkable deposits and travelers' checks; equivalents to the currency that can be quickly converted to cash
• M2: Includes M1 and adds savings accounts (up to $100,000) and non-institutional money market (short-term debt market) accounts
• M3: Includes M2, institutional money market accounts, and larger deposits in banks

These measurements allow governments and central banks to do exactly that: measure. 

M2 acts as the main currency supply metric for the U.S. Federal Reserve and aids in forecasting inflation. 

Since it significantly impacts the economy, it is constantly altered by the Fed in line with whatever monetary policy is in place. 

To increase the supply of legal tender, the Fed can buy back treasury bonds or mint more cash, and to decrease it, the Fed can sell treasury bonds. These are examples of how the Fed affects "the Ms."

The future of money

In 2009, an anonymous developer operating under Satoshi Nakamoto created the first decentralized cryptocurrency, Bitcoin. 

Starting at 8 cents, Bitcoin reached a high of approximately $68,000 in November 2021. Bitcoin and decentralized cryptocurrency as a whole use blockchain technology. 

Put as simply as possible. The blockchain provides a public ledger of every Bitcoin transaction ever completed. 

The majority must approve each transaction of "nodes." Each "node" is someone who voluntarily allows the blockchain to use their computer's processing power to validate transactions. 

New coins are minted through "mining," where a computer completes a complicated math problem in exchange for coins. 

This system, created by Bitcoin, has allowed cryptocurrencies to flourish. As a result, some believe that crypto is the future of currency since it allows a coin to exist and maintain value without a central power controlling it. 

For now, however, the extreme volatility makes it hard to work as a store of value, not fulfilling one of the three main functions of currency. 

As the blockchain continues to evolve, we might look back at the present as the wild west of cryptocurrency, with soaring gains, meteoric losses, and new coins created every hour.

Researched and authored by James Fazeli-Sinaki | LinkedIn

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Cash Management
• Cost of Goods Manufactured (COGM)
• Economics
• Marginal Cost Formula