Money. It’s something that we all earn and spend. Some of us even borrow money. Others lend money. But have you ever stopped and asked the question: What is money?
It’s a question that may be worth asking. After all, money plays a significant part in all our lives.
Money is simply a means through which you can acquire goods and receive services. That “means through which” part is super important. That’s because money is just a tool—something you use to get something else.
How does money have any value? Because people trust that the money they use has value today and will continue to have value in the future.
Yes, money can take the form of banknotes and coins. But it is more than cash. It is also deposits held in bank accounts or on your debit cards. It is funds accessible to you through any credit cards you have. It is purchasing power you obtain by taking a loan from someone.
In a broader nationwide sense, money even includes debt that’s created by commercial banks whenever they lend money to customers.
(Fiat currency is money that has no intrinsic value and is declared legal tender by a government. Examples of fiat currencies include the U.S. dollar, Japanese yen and Australian dollar.)
Functions of Money
If money didn’t exist, the amount of goods and services that society could produce and trade would be severely less than what we see today.
Before money, societies used a barter system—a system of exchange where people directly exchange goods and services. Whilst this can work, it is highly inefficient and severely restricts the development of an economy. The biggest limitation of a barter system is that both parties need to have what the other wants.
Take a farmer who specialises in growing corn for example. This farmer wants some fish to cook and eat, so they travel to the market with their corn. For the farmer to get fish, they need to not only find a fishmonger, but a fishmonger who is wanting corn. Good luck with that!
This brings us to one of the main functions of money: A medium of exchange. Taking the above example and replacing a barter system with a money system, all the farmer has to do is find a fishmonger and pay them money for some fish. No longer does the farmer have to waste time searching for a fishmonger who just so happens to want corn.
Money—be it in the physical or digital form—also functions as a unit of account. This just means that money is able to provide a unit of measurement for defining, recording, and comparing value.
For example, in Australia the price of an iPhone 11 is roughly $1,200. As for an iPhone SE, it costs about $750. Because money functions as a unit of account, we know that people perceive an iPhone 11 as being more valuable than an iPhone SE.
Finally, money functions as a store of value. Because the value of money is relatively stable over a long period, you’re able to put aside some money and be confident that you can still use it later on. If money’s value becomes volatile and unpredictable, it gets a lot more difficult to save and budget.
Properties of Money
To be able to function as a medium of exchange, unit of account, and store of value, it helps if money has a number of certain properties. These properties are briefly described below.
- Fungible: Each unit of money is easily swappable for another because they are of equal value. For example, swapping a $5 note for a couple of $2 coins and a $1 coin.
- Durable: In its physical form, money takes a long time to wear out. It can be used over and over again.
- Divisible: Money doesn’t just come in one size only. Rather, it can be divided into smaller units of value. For example, there are 100 cents in every dollar.
- Portable: You can carry money with you and easily transfer it physically via notes and coins; digitally via mobile phones, smart watches, and computers; or electronically via debit and credit cards.
- Recognisable: It is widely accepted that people have the right to use money. Money is treated as an authentic way to complete transactions.
- Uniform: There are no distortions in any monetary denomination. Any version of any given denomination will always have the same purchasing power. For example, you can buy the same amount of things with a pair of $10 notes as you can with a $20 note.
- Scarce: There is no unlimited supply of money. At any moment, there is a finite supply of money in existence. This helps keep the value of money relatively constant over the long term.
How Is Money Made?
Physical forms of money are produced. In Australia, banknotes are printed by Note Printing Australia—which is a subsidiary of the Reserve Bank of Australia (RBA). As for coins, they are produced by the Royal Australian Mint.
Beyond banknotes and coins, there is a far greater pool of money created in a more intangible way, through digital, electronic and ledger-based accounting records.
For example, when a finance company or bank lends you money, they will accumulate money over time as money is progressively deposited via your loan repayments. Meanwhile, you spend your borrowed money immediately because that amount will be credited to your bank account. The act of spending this borrowed money expands the amount of money in circulation. It “creates” money.
Of course, regulatory restraints exist to make sure banks don’t lend out too much money. In many countries, banks are required to keep a certain percentage of their cash holdings. This percentage is called the ‘reserve requirement’ or ‘cash reserve ratio’.
Money & Bitcoin
Cryptocurrencies like bitcoin (BTC) are often touted as an improvement on money as we know it today. As for whether bitcoin is or is not money, the jury remains out.
Since the Bitcoin network launched in January 2009, more and more people have been using bitcoin as a medium of exchange. Nowadays, you can use bitcoin to pay for just about anything, be it your electricity bill, a new phone, or a coffee.
Historically, the price of bitcoin has moved up and down sharply. This is widely believed to weaken the argument that bitcoin is money because, as covered earlier, money needs to function as a store of value in order for it to work properly.
Read: What Is Bitcoin?