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Money
Theory 1 - Money - what is it and who needs it?
Money is anything that is generally acceptable as a means of exchange. Anything could be used as money providing there was a general acceptance that it could be used to acquire the things we need. At this moment in time we use bits of paper and metal (notes and coins). We all accept that if you are offered a £10 pound note for an object you are willing to sell (assuming it is the right value) then it would be acceptable because you know you could then use that very same note to buy the things you wanted from someone else. This is why, in the past, all manner of items have been used as money - cigarettes, shells, etc.
However, this does not mean that every system of money is a good system. To be a 'good' money system, it has to have a number of characteristics. The closer the system is to all these characteristics the better the system. The important point with any money system is to remember that we are interested in what the money can actually buy rather than the means by which we acquire goods and services. In modern society, the use of notes and coins as the means of exchange is decreasing as we find other methods of acquiring what we need. Notably 'plastic' in the form of credit and debit cards. Does this mean they are a form of money? Look at the characteristics below to decide for yourself whether they meet the definition of 'money'.
The answer to the question in the title is of course simple - we all do! But why do we need it? What do we need it for? These are more important questions than you may think, because we need to know the answers if we are to have 'sound money'. We therefore need to know the functions of money, in other words the things we need money to be able to do. They are:
- A medium of exchange - probably the most obvious function of money, we need money to be able to spend. We need something that is generally acceptable as a means of payment for goods and services.
- A store of value - we also want to be able to use money to store our wealth. We want to be able to keep money and spend it in the future as well as the present. If money is to fulfil this function, there must be price stability (low inflation), or money will lose its value over time. In other words we want to be certain (or as certain as possible) that the £10 in our pocket today will buy the same amount of goods and services as £10 in three weeks time, or three months time or even three years time!
- A unit of account - money has to act as a way for people to measure values of goods and services. We all have different views about the value of things. The ring given to us by a loved one may be very valuable to us personally and may be regarded as 'priceless' This can be overcome to some extent by a common unit of account - we all have some idea of what £10 is worth to us.
- A standard of deferred payment - money has to be valid for future claims as well as present ones. Firms will want to set the level of wages for the future; they want to be able to pay bills after a period of credit has expired and so on. Money has to act as a way of setting these future payments. I want to know what that the monthly wage I am going to earn will be in six months time - it gives me a standard to measure future payments made and received.
These functions alone don't tell us what would make a good type of money. As mentioned above, various things have been used as money. So why do we not still use these? What attributes do we need money to have, if it is to be a 'good' form of money?
- Acceptability - if money is to be an effective medium of exchange, it has to be universally acceptable (or at least acceptable within the country or origin).
- Divisibility - money has to be able to be conveniently split into multiple units for convenient payment. (Cows might be a useful source of money but they would certainly lose their value if cut up to pay for small items!)
- Portability / convenience - money has to be convenient to carry around. (Ever tried slipping a cow into your back pocket?)
- Difficult to counterfeit - a lot of effort goes into ensuring that people cannot easily copy money.
- Durability - money has to last well if it is to act as a store of value and standard of deferred payment. Your money won't fulfill these functions very well if you end up smoking it or losing it in a card game! There is a real issue with this even with notes and coins - Five pound notes have a short life span because they are used too regularly - how long before we get a five pound coin?
- Uniformity - money has to be of a uniform quality to ensure that it remains universally acceptable.
- Limited in supply - if it is to maintain its value, the supply of money has to stay limited. Using leaves as money, for example, would create a money supply problem in the autumn! This last point is the reason why cigarettes have been used as currency in the past - it is because they were limited in supply relative to the demand and therefore had some value!
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