XI. Text b

Function and Characteristics of Money

Money helps bring simplicity and organization to our economy. It is something people are willing to accept in exchange for the output they have produced and have available. Money is our medium of exchange (1).

Throughout history, societies have used various items as the medium of exchange, everything from playing cards to shells to furs to gold. For one reason or another, these items became acceptable in some societies as forms of payment for goods and services. As soon as anything is readily accepted in a society as money, it can serve as a medium of exchange. That is the most important criterion for anything to serve as money—it must be readily acceptable.

Another function of money we noted was that it serves as a standard of value or a unit of account (2). That is, money serves as a common item in which the prices of all goods and services can be set. If a person wants a computer, he or she doesn’t have to calculate how many loaves of bread will be necessary in order to buy it, how many painted houses, how many rocking chairs, or how many taxi rides. Instead of setting millions of prices for a television in terms of all other goods and services produced, one price is set. And the prices of all other goods and services are set in the same unit of account.

And money has come to serve as a store of value (3). Rather than using money for spending today, you can store (save) it for use in the future.

We want our money to enable us to save, that is, to postpone using some of our current income for use in the future. One of our goals in saving is usually to ensure that the value of our savings doesn’t decrease over time.

To summarize, money serves three key roles: a medium of exchange (1), a unit of account (2), and a store of value (3).

That’s what money does. It helps our economy to work more smoothly. It simplifies the trading (transactions) process.

Now almost every society has a money economy based on coins and paper bills of one kind or another.

Although, as we see, anything can serve as money, as a practical matter the material should possess the following qualities: (1) durability, (2) divisibility,

(3) transportability, and (4) noncounterfeitability.

Almost any item, any asset, any "thing" can function as money so long as it is generally accepted as payment. In fact, a lot of different "things" have been used as money over the centuries-gold, silver, copper, nickel, animal skins, chocolate bars, cigarettes, precious gems, semi-precious gems, really precious gems, and assorted food products.

While a number of "things" have been used as money, some have worked better than others. Those "things" that did not work so well were replaced by other "things" that worked better. Those "things" that worked best tended to have four basic characteristics: durability, divisibility, transportability, and noncounter-feitability.

Durability. This first characteristic means that an item retains the same shape and substance over an extended period of time; that it does not easily decompose, deteriorate, degrade, or otherwise change form.

People are willing to accept an item in payment for one good because they are confident that the item can be traded at a later time for some other good. An item works as a medium of exchange precisely because it stores value from one transaction to the next. And this requires durability.

While physical durability has been historically important for money, social and institutional durability is also important for modern economies. The durability of modern money, especially paper currency and bank account balances, depends on the durability of social institutions–especially banks and governments. While government-issued paper currency might remain physically intact for centuries, its ability to function as money depends on the institutional durability of the government.

Divisibility. This second characteristic means money can be divided into small increments that can be used in exchange for goods of varying values. For an item to function as the medium of exchange, which can be used to purchase a wide range of different goods with a wide range of different values, then it must be divisible. Divisibility is one reason why metals, such as gold, silver, copper, and nickel, have been widely used as money throughout history.

Transportability (portability). Money’s ability to be carried from one place to another and transferred from one person to another is its portability as a medium of exchange, money must be convenient for people to use. Items that are difficult to carry make poor money.

Once again, transportability has played a key role in the use of metals like gold, silver, copper, and nickel as money. However, these metals were largely replaced by paper currencies in the 20th century because paper was lighter and easier to carry.

Noncounterfeitability. This fourth characteristic means that money cannot be easily duplicated.

Preventing the unrestricted duplication of money is a task that has long been relegated to government. In fact, this task is one of the prime reasons why governments exist. An economy needs government, to regulate the total quantity of money in circulation. By controlling money duplication, governments are also able to control the total quantity in circulation, and this control is what gives money value in exchange.