Money

I

Introduction

Money, any medium of exchange that is widely accepted in payment for goods and services and in settlement of debts. Money also serves as a standard of value for measuring the relative economic worth of different goods and services. The number of units of money required to buy a commodity is the price of the commodity. The monetary unit chosen as a measure of value need not, however, be used widely, or even at all, as a medium of exchange. During the colonial period in North America, for example, Spanish currency was an important medium of exchange, while the British pound sterling served as the standard of value.

II

Money and the Economy

The functions of money as a medium of exchange and a measure of value greatly facilitate the exchange of goods and services and the specialization of production. Without the use of money, trade would be reduced to barter, or the direct exchange of one commodity for another; this was the means used by primitive peoples, and barter is still practised in some parts of the world. In a barter economy, a person having something to trade must find another who wants it and has something acceptable to offer in exchange. In a money economy, the owner of a commodity may sell it for money, which is acceptable in payment for goods, thus avoiding the time and effort that would be required to find someone who could make an acceptable trade. Money may thus be regarded as a keystone of modern economic life.

III

Types of Money

The most important types of money are commodity money, credit money, and fiat money. The value of commodity money is about equal to the value of the material contained in it. The principal materials used for this type of money have been gold, silver, and copper. In ancient time, various articles made of these metals, as well as of iron and bronze, were used as money, while among primitive peoples such commodities as shells, beads, elephant tusks, furs, skins, slaves, and livestock served as media of exchange. Credit money is paper backed by promises by the issuer, whether a government or a bank, to pay an equivalent value in the standard monetary metal. Paper money that is not redeemable in any other type of money and the value of which is fixed merely by government edict is known as fiat money. Most minor coins in circulation are also a form of fiat money, because the value of the material of which they are made is usually less than their value as money.

Both the fiat and credit forms of money are generally made acceptable through a government decree that all creditors must take the money in settlement of debts; the money is then referred to as legal tender. If the supply of paper money is not excessive in relation to the needs of trade and industry and the people feel confident that this situation will continue, the currency is likely to be generally acceptable and to be relatively stable in value. If, however, such currency is issued in excessively large volume in order to finance government needs, confidence is destroyed and it rapidly loses value. Such depreciation of the currency is often followed by formal devaluation, or reduction of the official value of the currency, by governmental decree.

IV

Monetary Standards

The basic money of a country (or group of countries, as in the case of the European Union and the Euro), into which other forms of money may be converted and which determines the value of other kinds of money, is called the money of redemption or standard money. The monetary standard of a nation refers to the type of standard money used in the monetary system. Modern standards have been either commodity standards, in which either gold or silver has been chiefly used as standard money, or fiat standards, consisting of inconvertible currency paper units. The principal types of gold standard are the gold-coin standard; the gold-bullion standard consisting of a specified quantity of gold; and the gold-exchange standard, under which the currency is convertible into the currency of some other country on the gold standard. The gold-bullion standard was used in Great Britain from 1925 to 1931, while a number of Latin American countries have used the dollar-exchange standard. Silver standards have been used in modern times chiefly in the Orient. Also, a bimetallic standard, the system of bimetallism, has been used in some countries, under which either gold or silver coins were the standard currency. Such systems were rarely successful, largely because of Gresham's law, which describes the tendency for cheaper money to drive more valuable money out of circulation.

Most monetary systems of the world at the present time are fiat systems; they do not allow free convertibility of the currency into a metallic standard, and money is given value by government fiat or edict rather than by its nominal gold or silver content. Modern systems are also described as managed currencies, because the value of the currency units depends to a considerable extent on government management and economic policies. It is a recurrent problem whether the value of inconvertible-credit currency can be maintained at a fairly stable level for extended periods of time.