Economists define money, where it comes from, and what it’s worth. Here are the multifaceted characteristics of money. Today’s fast money is another means of liquidity. Failing to see the most ingrained details of the income helps our insight to widen the aspects of income.
- Money is a medium of exchange; it allows people to obtain what they need to live with.
- Bartering was one way that people exchanged goods for other goods before money was created.
- Like gold and other precious metals, money has worth because for most people it represents something valuable.
- Fiat money is the government-issued currency that is not backed by a physical commodity but by the stability of the issuing government.
Also Read: The Key to Money Management!
Money a medium of exchange
Let us go by the standard definition, it is a standard numerical unit of measurement of the market value of goods, services, and other transactions.
- Early forms of bartering, however, do not provide the transferability and divisibility that makes trading efficient.
- For instance, if someone has cows but needs bananas, they must find someone who not only has bananas but also the desire for meat.
- What if that individual finds someone who requires meat but no bananas and can only offer potatoes? To get meat, that person must find someone who has bananas and wants potatoes, and so on.
- The lack of transferability of bartering for goods is tiring, confusing, and inefficient.
But that is not the end of the problems; even if the person finds someone with whom to trade meat for bananas, they may not consider a bunch of bananas to be worth a whole cow.
Gradually as people devised commodity money, it solved these problems. Commodity money is a type of good that functions as a currency.
Also Read: 5 Money Rules To Increase Your Net Worth
In the 17th and early 18th centuries, for example, American colonists used beaver pelts and dried corn in transactions. Possessing generally accepted values, these commodities were used to buy and sell other things.
The commodities used for trade had certain characteristics: they were widely desired and, therefore, valuable, but they were also durable, portable, and easily stored.
Another, more advanced example of commodity money is a precious metal such as gold. For centuries, gold was used to back paper currency—up until the 1970s. In the case of the U.S. dollar, for example, this meant that foreign governments were able to take their dollars and exchange them at a specified rate for gold with the U.S. Federal Reserve.
- Unlike the beaver pelts and dried corn (which can be used for clothing and food, respectively), gold is precious purely because people want it.
- It is not necessarily useful—you can’t eat gold, and it won’t keep you warm at night, but the majority of people think it is beautiful, and they know others think it is beautiful. So, gold is something that has worth.
- Gold, therefore, serves as a physical token of wealth based on people’s perceptions.
- This relationship between money and gold provides insight into how money gains its value—as a representation of something valuable.
Also Read: YO! Get your Money Straight!
Belief Creates Everything
The second type of money is fiat money, which does not require backing by a physical commodity. Instead, the value of fiat currencies is set by supply and demand and people’s faith in its worth.
Fiat money developed because gold was a scarce resource, and rapidly growing economies growing couldn’t always mine enough to back their currency supply requirements.
Most important to have it at the back of the head is, for a booming economy, the need for gold to give money value is extremely inefficient. Especially when its value is created by people’s perceptions.
Fiat money becomes the token of people’s perception of worth, the basis for why money is created.
An economy that is growing is succeeding in producing other things that are valuable to itself and other economies. The stronger the economy, the stronger its money will be perceived (and sought after) and vice versa.
However, people’s perceptions must be supported by an economy that can produce the products and services that people want.
Also Read: Some Crucial Money Savvy Tips For You
Value of money is dictated by inflation!
Today, the value of money (not just the dollar, but most currencies) is decided purely by its purchasing power, as dictated by inflation.
That is why simply printing new money will not create wealth for a country. Money is created by a kind of a perpetual interaction between real, tangible things, our desire for them, and our abstract faith in what has value.
Money is valuable because we want it, but we want it only because it can get us a desired product or service.
How Is Money Measured?
But exactly how much money is out there, and what forms does it take? Economists and investors ask this question to determine whether there is inflation or deflation.
Thus, we could oddly say, money is more of liquidity in terms economists and investors.
Money is separated into three categories so that it is more discernible for measurement purposes:
- Money in physicality (M1)– This category of money includes all physical denominations of coins and currency; demand deposits, which are checking accounts and NOW accounts; and travellers’ checks. This category of money is the narrowest of the three and is essentially the money used to buy things and make payments (see the “active money” section below).
- Money in deposits (M2)– With broader criteria, this category adds all the money found in M1 to all time-related deposits, savings accounts deposits, and non-institutional money market funds. This category represents money that can be readily transferred into cash.
- (M3) The broadest class of money – M3 combines all money found in the M2 definition and adds to it all large time deposits, institutional money market funds, short-term repurchase agreements, along with other larger liquid assets.
- By adding these three categories together, we arrive at a country’s money supply or the total amount of money within an economy.
- The M1 category includes what’s known as active money—the total value of coins and paper currency in circulation. The amount of active money fluctuates seasonally, monthly, weekly, and daily.
- For example, Banks lend money out to customers, which becomes active money once it is actively circulated.
- The variable demand for cash equates to a constantly fluctuating active money total.
- For example, people typically cash paychecks or withdraw from ATMs over the weekend, so there is more active cash on a Monday than on a Friday. The public demand for cash declines at certain times—following the December holiday season, for example.