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 [1]. 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. Money may also serve as a means of rationing access to scarce resources and as a quantitative measure that provides a common standard for the comparison and valuation of quality as well as quantity, such as in the valuation of real estate or artistic works.

The use of money provides an easier alternative to barter, which is considered in a modern, complex economy 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.

Like language, money is a social organization and civilizing force that provides a means and incentive for human beings to relate to one another economically by exchanging goods and services for mutual benefit. The capacity to convert perishable commodities and non-storable human labor into money provides a powerful incentive for people to produce more than they need for present personal consumption and to convert the surplus value into money so that it can be stored to meet future needs. Thus, the invention of money has stimulated the development of society by fostering hard work, higher productivity and continuous innovation. In addition to its economic functions and capacities, money has acquired other secondary social and psychological powers that may be exercised either by the expenditure of money or by its mere possession: these include the power to enhance popularity, status and prestige, the capacity to enhance the sense of self-worth, and the power to attain or influence political power.




A number of commodity money systems were amongst the earliest forms of money to emerge. For example

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 besides its value due to monetary usage, whereas paper notes are only worth as much as the monetary value assigned to them. Other forms of commodity money included the use of Commodity money is usually adopted to simplify transactions in a barter economy, and so it functions first as a medium of exchange. It quickly begins functioning as a store of value[citation needed], since holders of perishable goods can easily convert them into durable money.

The bulkiness and limited transportability of some forms of commodity money led to the invention of symbolic substitutes for commodity money. Goldsmiths' receipts became an accepted money-substitute for gold in 17th Century England. The goldsmiths were the precursors of leading banks in England and the receipts they issued were the precursors of the banknote. Through most of the 19th Century commercial banks in Europe and North America issued their own banknotes based on the same principle of partial backing.

Many people are under the misimpression that the US dollar and other national currencies were fully convertible into gold prior to abolition of the gold standard in the early 1970s. But through most of the 19th century, gold or silver backing for national currencies was never more than partial and only intended to facilitate international transactions.

From there is was only one further step to create true Fiat money, currency that has negligible inherent value and is not backed by any commodity. A central authority (government) creates a new money object by issuing paper currency or creating new bank deposits. The widespread acceptance of fiat money is most frequently enhanced by the central authority mandating the money's acceptance as legal tender under penalty of law and demanding this money in payment of taxes or tribute. By the early 1970s almost all countries had abandoned the gold standard and converted their national currencies to pure fiat money.


Social Evolution of Money

Money is an invention of the human mind. The creation of money is made possible because human beings have the capacity to accord value to symbols. Money is a symbol that represents the value of goods and services. The acceptance of a any object as money – be it wampum, a gold coin, a paper currency note or a digital bank account balance – involves the consent of both the individual user and the community. Thus, all money has a psychological and a social as well as an economic dimension. As human consciousness has evolved, the nature and function of money has evolved too. While a history of money may trace the origin and usage of different forms of money at different times and in different parts of the world, an evolutionary perspective on money traces the social and psychological changes in human attitude and collective behavior that made possible this historical development.



Money is generally considered to have the following three characteristics:

1. It is a medium of exchange

The essential function of money is that of acting as a medium of exchange.

Newlyn, W. T. [1962] (1970). “I Definitions and Classifications”, Ed. Clarendon Press Oxford Theory of Money. London: Oxford University Press, p. 1. “The essential function, the performance of which enables us to identify money, is very simple: it is that of acting as 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.


Desirable features

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

To be a medium of exchange:

To be a unit of account:

To be a store of value:

To be anonymous:

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.

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


Modern forms

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. Money is used to buy goods and services, whereas credit buys goods and services on the promise to pay with money in the future.

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 monetary aggregrates, but the publication of M3 was discontinued by the RBA in March, 2006.


Creation of Money

Although types of money are easily identified and distinguished, the actual nature of money and the manner in which it is created is less easily understood. The fact that commodities such as gold, silver, furs or tobacco leaves have value does not make any of them money. It becomes money only when it is widely accepted as a symbol representing a certain value of goods and services and readily accepted in exchange for other goods and services of commensurate perceived value. Trust in its authenticity and universal acceptance and confidence in the availability of goods and services for redemption are essential criteria.

The creation of money is also a subject of considerable confusion and superstition. The creation of commodity money was made possible by the discovery or production of more of the particular commodity, such as gold or barley. As commerce expanded, trade became the primary means for creation of new money. Traders supplied goods to their buyers on credit through bills of exchange which the buyer endorsed and promised to pay within a given period of time. Bills endorsed by credit-worthy buyers or their guarantors then become a form of currency that could be used by the note holder to make additional purchases. At a later date banks became the principle source of new money. Banks take in deposits and issue loans to borrowers either by paying out some of the currency receipted on deposit or simply by creating a new deposit in the borrowers account without receiving currency to back it up. By this means banks create many times more money than the amount they receive or hold on deposit. Central banks in turn further multiply the amount of currency and demand deposits by printing additional currency and using it to purchase government bonds or by lending it to commercial banks by creating fresh deposits at the central bank for the bank just as the bank does for its own borrowers.

See also Social evolution of money


Problems with precious metals as money (specie)

There is no perfect money, although it is argued that silver or gold may come close to this standard. Gold is too valuable to use for small purchases, and silver is too heavy and bulky in large quantities. Today, since gold is demonetized and forced to compete with paper currencies it does have a spread of about 1-4% to buy and sell in terms of the paper currency, whereas paper money can be exchanged freely. The exchange premium comes from the relative scarcity of people to exchange paper for gold or silver. The scarcity has resulted in having to pay coin dealers a small profit for the service. If silver and gold were remonetized, then there would be no shortage of sources for exchange. Accordingly the premiums charged would drop to nothing in an economy that recognized silver or gold as lawful money. Although gold itself does not decay, gold coins are easily scratched or damaged, and this can reduce their value and fungibility. From 1980 to 2001, gold was a poor store of value, as gold prices dropped from a high of $850/oz. to a low of $255/oz. The advantage of gold and silver, however, lies in the fact that, unlike fiat paper currency, the supply cannot be increased arbitrarily by a central bank.

On the other hand, gold, silver and other metals are subject to regular and sometimes extraordinary supply increases and decreases. They are virtually created by being dug out of the ground, although there is a cost for this. In the 16th century the Spanish possessions in the Americas produced huge amounts of new money, which produced economic fluctuations throughout the world. Similarly, precious metals are subject to hoarding by individuals, sometimes in the form of jewellery, sometimes as coins or ingots. While this may be rational behaviour for indivduals (as gifts, or savings, or an expression of fear about future circumstances) this results in an increase in the amount of "dead" (i.e. non-circulating) money, a decrease in supply and possibly an increase in the value of the metal. Imbalances between the values of gold, silver and other metals, possibly caused by the fluctuations of such supplies and demands have often led to scarcity of coins in many societies. Shipping coins from one jurisdiction to another so that they could be reminted was sometimes a lucrative trade before the advent of trusted paper money.


Problems with paper as money

Due to the ease of production, paper money may lose value through inflation and, in today's electronic era, vast quantities of money can be created with a few key strokes. Perhaps the biggest criticism of paper money relates to the fact that its stability is generally subject to the whim of government regulation rather than the disciplines of market phenomena. Paper money can be easily damaged or destroyed by everyday hazards: from fire, water, termites, and simple wear and tear. Money in the form of minted coins is sometimes destroyed by children placing it on railroad tracks or in amusement park machines that restamp it. Mexico has changed its twenty peso note and Singapore its $2 and $10 bills to plastic for the increased durability. Paper money is also subject to counterfeiting.


Basis for value of money

The value of money depends on what it can purchase, not what it is made of. Fiat money has value because it can be utilized to purchase goods and services, even though it has no intrinsic value or utility other than as a medium of exchange. It is more difficult to concede that the same is true of gold and silver. While their intrinsic value remains unaltered by the quantity available, their value as a medium of exchange is directly depend on the availability of goods and services for sale. This is illustrated by the fact that when huge quantities of gold and silver were discovered in the New World and brought back to Europe for conversion into coin, the purchasing power of those coins fell by 60% to 80%, i.e. prices of commodities rose, because the supply of goods for sale did not keep pace with the increased supply of money.[1]

Today's national currencies are back by the governments that issue them, not by gold or silver, and the governments are backed by the productive capacity of the societies they represent.



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.


Linkages between money and other social institutions

The evolution of money illustrates how each new social institution creates linkages with other existing social institutions as it develops and those linkages gradually expand into complex networks of relationships until they become inseparable elements of a single social web. The evolution of money began as a medium of exchange and measure of value money, thus serving as a stimulant for the exchange of goods and services. As a medium for storage of value, it gave rise to banking. By creating and lending money, banks became catalysts for the further development of trade and industry. In the form of taxation, money supported the development of government. These linkages are direct expressions of the primary powers of money to facilitate transactions.

In addition, money exercises secondary influences on the society. Politically, the right to collect taxes helped monarchy centralize power and influence in a national government. At a later stage, the ever increasing need of that government for more funds made it increasingly dependent and subject to those sections of society that possessed or controlled large sums of money. The English Parliament eventually rested power from the king by first acquiring the sole right to raise taxes, paving the way for democracy. Later the wealthy merchant class acquired increasing influence over the political establishment. Socially, money has helped breakdown the rigid class structure which allocated privileges according to one’s birth. In a money economy access to goods and services is based on the capacity to pay rather than one’s social origins. Thus it helps eliminate social discrimination based on caste and class.


Private currencies

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

A private 1 dollar note, issued by the "Delaware Bridge Company" of New Jersey 1836-1841.
A private 1 dollar note, issued by the "Delaware Bridge Company" of New Jersey 1836-1841.

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." 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 material, although some people argue about perishable materials. The material used to back money changes with the times. Gold, silver, and platinum now have, in some regards, less utility than they did previously (their electrical properties notwithstanding). This makes things such as energy (measured in joules), transport (measured in kilogramme*kilometre/hour), or food [2] more useful for backing money. It is important to understand that 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 a certain material or should be totally virtual.


The Future of Money

In recent years, the Euro was introduced to many nations in Europe, which now all use one currency.

West Africa is proposing to introduce the Eco, a new currency for 5 or 6 nations, by 2009.

It is speculated that a North American currency, such as the Amero might come next. An Asian Currency Unit is also proposed.

In the Middle East, many nations use the dinar. An Islamic gold dinar is also proposed.

In Mexico, there is a movement to return to using silver as money. [2]

One difficulty with currency blocks unifying paper currencies is that it may eliminate the ability of trillions worth of dollars to be exchanged on currency markets. If this kind of trading were to move into the gold and silver markets, the prices for gold and silver could soar.

Today, gold and paper money can be traded electronically via online systems. Perhaps ultimately the world will end up trading gold and silver in electronic form.



U.S. Money Supply from 1959-2006
U.S. Money Supply from 1959-2006

The money supply is the amount of money available within a specific economy available for purchasing goods or services. The supply in the United States 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 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, 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.


Benchmark world currencies

These are the major currencies used in trading[3].

Besides these currencies gold and silver are traded globally on the currency markets:


Quotes on money


See also




  1. Galbraith, J.K., Money: Whence it came, where it went,Penguin, UK, 1975, p.20-21.
  3. benchmark World Currencies at Bloomberg

External links

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