MONEY

a commodity accepted by general consent as a medium of economic exchange. It is the medium in which prices and values are expressed; it circulates from person to person and country to country, thus facilitating trade, and it is the principal measure of wealth. The concept of money occupies a central place in economic theory. Money's form, shape, or substance is of relatively little significance (although convenience of handling and measurement is an important factor); its more crucial characteristic is that it is commonly accepted in payment for other goods and services. Throughout history a large number of commodities have been used as money (including seashells, beads, stone disks, and cattle), but since the 17th century the most common forms have been metal coins, paper notes, and bookkeeping entries. In standard economic theory, money is held to have four distinct but interrelated functions: (1) to serve as a medium of exchange, a commodity universally accepted in exchange for goods and services and for the discharge of debts or contracts; (2) to act as a measure of value and a unit of account, a common yardstick that makes the operation of the price system possible and provides the basis for keeping accounts and calculating cost, profit, and loss; (3) to serve as a standard of deferred payments, the unit in which loans are made and future transactions are fixed. Without money there would be no commonly accepted basis for borrowing and lending, and the concept of credit could not play the significant role in the economy that it does; and (4) to provide a store of wealth, a convenient form in which to hold any income not immediately required for use. This asset function of money provides a reserve of ready purchasing power. Money is the only completely liquid asset (that is, one readily convertible into other goods). Metals, especially gold and silver, have been used for money for at least 4,000 years. For perhaps 2,600 years, standardized coins have been the form in which money metals circulate. Gold and silver coins contain legally specified amounts of gold or silver and are theoretically equal in value to that quantity of the metal. Coins or uncoined bullion, however, can be an inconvenient and insecure mode for conveying large quantities of value. For large transactions, various forms of paper notes may be used to represent promises to pay in gold or silver. In the late 18th and early 19th centuries, banks began issuing such notesbanknotesto represent convenient denominations of money. Each banknote was redeemable for gold or silver. This fiduciary moneymoney consisting of promises to pay in another mediumbecame the principal money of growing industrial economies. Eventually, for a variety of practical reasons, the circulating coinage began to be made of base metals, also taken to represent gold or silver on deposit somewhere and available on demand. Temporarily during World War I and permanently from the era of the Great Depression of the 1930s, the gold standard was abandoned by most nations, meaning that paper money was no longer convertible to gold on demand. Paper money issued on the general credit of a nation and not based on deposits of money metal is often called fiat money. To most individuals, money consists of coins, banknotes, and the amount of readily usable deposits held in banks and other financial institutions. As far as the economy is concerned, however, the total money supply is several times as large as the sum total of individual money holdings defined in this way. This is because a very large proportion of the deposits placed with financial institutions is loaned out, thus multiplying the overall money supply several times over. In fact, the money supply of a modern financial system includes a wide range of deposits, instruments of credit, and commercial bills. In this sense the best definition of money is by what it does: if an item is accepted as payment for goods, it can be regarded as money. The concept of money supply has come to play an increasingly important role in economic policymaking, because many economists believe that it is the quantity of money within the economy that ultimately determines real price levels, the rate of economic growth, and the rate of inflation. Near money refers to assets that, although not totally liquid, can be converted into cash at short notice, such as securities, insurance policies, and some building society loans. Hot money usually refers to funds that are moved from one country to another on a short-term basis in search of some temporary advantage. Call money is short-period loans made to banks that are repayable on demand. Overnight money denotes loans made each day and automatically repaid the following morning. a commodity accepted by general consent as a medium of economic exchange. It is the medium in which prices and values are expressed, it circulates from person to person and country to country, thus facilitating trade, and it is the principal measure of wealth. The subject of money has fascinated wise men from the time of Aristotle to the present day because it is so full of mystery and paradox. The piece of paper labelled one dollar or 100 francs or 10 kroner or 1,000 yen is little different, as paper, from a piece of the same size torn from a newspaper or magazine, yet it will enable its bearer to command some measure of food, drink, clothing, and the remaining goods of life while the other is fit only to light the fire. Whence the difference? The easy answer, and the right one, is that people accept money as such because they know that others will. The pieces of paper are valuable because everyone thinks they are, and everyone thinks they are because in his experience they always have been. At bottom money is, then, a social convention, but a convention of uncommon strength that people will abide by even under extreme provocation. The strength of the convention is, of course, what enables governments to profit by inflating the currency. But it is not indestructible. When great variations occur in the quantity of these pieces of paperas they have during and after warsthey may be seen to be, after all, no more than pieces of paper. People will then seek substituteslike the cigarettes and cognac that for a time became the medium of exchange in Germany after World War II. As John Stuart Mill wrote: There cannot, in short, be intrinsically a more insignificant thing, in the economy of society, than money; except in the character of a contrivance for sparing time and labour. It is a machinery for doing quickly and commodiously, what would be done, though less quickly and commodiously, without it: and like many other kinds of machinery, it only exerts a distinct and independent influence of its own when it gets out of order. (Principles of Political Economy, W.J. Ashley , 1909, p. 488.) Mill was perfectly correct, although one must add that there is hardly a contrivance man possesses that can do more damage to a society when it goes wrong. Additional reading Works on various aspects of monetary history include: Phillip Cagan, The Monetary Dynamics of Hyperinflation, in Milton Friedman (ed.), Studies in the Quantity Theory of Money (1956); Rupert J. Ederer, The Evolution of Money (1964); Paul Einzig, Primitive Money in Its Ethnological, Historical, and Economic Aspects, 2nd ed. rev. (1966); Albert E. Feavearyear, The Pound Sterling: A History of English Money, 2nd ed. (1963); Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 18671960 (1963, reissued 1971), and Monetary Trends in the United States and the United Kingdom (1982); Elgin E. Groseclose, Money: The Human Conflict (1934); Earl J. Hamilton, American Treasure and the Price Revolution in Spain, 15011650 (1934, reprinted 1977); Henry C. Wallich, Monetary Policy and Practice (1982), articles on a variety of monetary topics by a former member of the Board of Governors of the Federal Reserve System.Useful readings in monetary theory, of varying levels of difficulty, include: Walter Eucken, This Unsuccessful Age (1952); Robert J. Gordon (ed.), Milton Friedman's Monetary Framework (1974); John G. Gurley and Edward S. Shaw, Money in a Theory of Finance (1960); Harry G. Johnson, Essays in Monetary Economics, 2nd ed. (1969); John Maynard Keynes, A Treatise on Money, 2 vol. (1930, reprinted 1976), and The General Theory of Employment, Interest and Money (1936, reprinted 1973); Don Patinkin, Money, Interest, and Prices: An Integration of Monetary and Value Theory, 2nd ed. (1965); and Dennis Holme Robertson, Money, 4th ed. (1956). Milton Friedman