If Money Was Not a Problem What Kind of Art Would You Purchase or Whose?

24.one What Is Money?

Learning Objectives

1. Ascertain coin and discuss its iii basic functions.
2. Distinguish between commodity coin and fiat money, giving examples of each.
3. Define what is meant by the money supply and tell what is included in the Federal Reserve System'southward 2 definitions of it (M1 and M2).

If cigarettes and mackerel tin can be used every bit money, then simply what is money? Money is anything that serves as a medium of exchange. A medium of commutation is annihilation that is widely accepted every bit a means of payment. In Romania nether Communist Party rule in the 1980s, for example, Kent cigarettes served as a medium of exchange; the fact that they could be exchanged for other goods and services made them money.

Money, ultimately, is defined by people and what they practice. When people utilize something as a medium of exchange, it becomes coin. If people were to brainstorm accepting basketballs equally payment for most goods and services, basketballs would be coin. Nosotros will larn in this chapter that changes in the way people use coin have created new types of money and changed the way money is measured in recent decades.

The Functions of Coin

Money serves 3 bones functions. By definition, it is a medium of commutation. It likewise serves as a unit of account and as a store of value—equally the "mack" did in Lompoc.

A Medium of Exchange

The exchange of goods and services in markets is among the about universal activities of human being life. To facilitate these exchanges, people settle on something that volition serve every bit a medium of exchange—they select something to exist money.

We can understand the significance of a medium of exchange by because its absence. Barter occurs when goods are exchanged directly for other goods. Because no 1 item serves as a medium of exchange in a barter economy, potential buyers must find things that individual sellers volition accept. A heir-apparent might discover a seller who will trade a pair of shoes for ii chickens. Another seller might be willing to provide a haircut in exchange for a garden hose. Suppose you were visiting a grocery store in a barter economy. You would need to load upwardly a truckful of items the grocer might accept in exchange for groceries. That would be an uncertain thing; you lot could non know when you headed for the store which items the grocer might agree to trade. Indeed, the complexity—and cost—of a visit to a grocery store in a castling economic system would be so great that there probably would not be any grocery stores! A moment'south contemplation of the difficulty of life in a castling economy will demonstrate why human societies invariably select something—sometimes more than one thing—to serve equally a medium of exchange, simply equally prisoners in federal penitentiaries accepted mackerel.

A Unit of Business relationship

Inquire someone in the Us what he or she paid for something, and that person will respond by quoting a toll stated in dollars: "I paid $75 for this radio," or "I paid $fifteen for this pizza." People do not say, "I paid five pizzas for this radio." That statement might, of course, be literally true in the sense of the opportunity cost of the transaction, merely we do not written report prices that style for two reasons. One is that people do not arrive at places similar Radio Shack with five pizzas and expect to purchase a radio. The other is that the information would non be very useful. Other people may not recall of values in pizza terms, so they might non know what we meant. Instead, nosotros report the value of things in terms of money.

Money serves as a unit of account, which is a consequent ways of measuring the value of things. We use money in this way because it is too a medium of exchange. When we study the value of a skilful or service in units of coin, we are reporting what another person is likely to have to pay to obtain that skillful or service.

A Shop of Value

The 3rd role of coin is to serve as a store of value, that is, an item that holds value over time. Consider a $xx bill that y'all accidentally left in a coat pocket a yr ago. When you detect information technology, you will be pleased. That is because you know the bill withal has value. Value has, in effect, been "stored" in that little slice of newspaper.

Coin, of grade, is not the just matter that stores value. Houses, office buildings, country, works of art, and many other commodities serve equally a ways of storing wealth and value. Money differs from these other stores of value by beingness readily exchangeable for other commodities. Its role equally a medium of exchange makes it a user-friendly store of value.

Considering money acts as a shop of value, information technology can exist used as a standard for future payments. When you borrow money, for example, you typically sign a contract pledging to make a series of future payments to settle the debt. These payments volition be made using money, because money acts as a store of value.

Coin is non a risk-free shop of value, nevertheless. We saw in the chapter that introduced the concept of inflation that inflation reduces the value of coin. In periods of rapid inflation, people may non want to rely on money equally a store of value, and they may turn to commodities such as land or golden instead.

Types of Money

Although money tin take an extraordinary diverseness of forms, there are actually only two types of money: money that has intrinsic value and money that does not have intrinsic value.

Commodity coin is money that has value autonomously from its use as coin. Mackerel in federal prisons is an example of commodity money. Mackerel could exist used to purchase services from other prisoners; they could likewise exist eaten.

Gold and silver are the most widely used forms of commodity money. Gold and silver can exist used as jewelry and for some industrial and medicinal purposes, and then they have value apart from their use as coin. The starting time known use of gold and argent coins was in the Greek city-state of Lydia in the beginning of the seventh century B.C. The coins were fashioned from electrum, a natural mixture of gold and silverish.

I disadvantage of commodity money is that its quantity can fluctuate erratically. Gold, for example, was one course of coin in the United States in the 19th century. Gold discoveries in California and afterwards in Alaska sent the quantity of coin soaring. Some of this nation'south worst bouts of inflation were prepare off by increases in the quantity of gold in circulation during the 19th century. A much greater problem exists with commodity money that tin exist produced. In the southern office of colonial America, for example, tobacco served as coin. There was a continuing problem of farmers increasing the quantity of coin by growing more than tobacco. The problem was sufficiently serious that vigilante squads were organized. They roamed the countryside burning tobacco fields in an effort to go along the quantity of tobacco, hence money, under command. (Remarkably, these squads sought to control the coin supply by burning tobacco grown by other farmers.)

Another problem is that commodity money may vary in quality. Given that variability, there is a trend for lower-quality commodities to drive higher-quality commodities out of circulation. Horses, for instance, served as coin in colonial New England. It was common for loan obligations to be stated in terms of a quantity of horses to exist paid back. Given such obligations, at that place was a tendency to utilize lower-quality horses to pay back debts; college-quality horses were kept out of circulation for other uses. Laws were passed forbidding the use of lame horses in the payment of debts. This is an example of Gresham's police: the tendency for a lower-quality commodity (bad coin) to drive a higher-quality commodity (proficient money) out of circulation. Unless a ways can be constitute to control the quality of commodity coin, the trend for that quality to turn down tin threaten its acceptability equally a medium of commutation.

Merely something need non have intrinsic value to serve as coin. Fiat money is money that some authority, more often than not a government, has ordered to be accustomed every bit a medium of exchange. The currency—paper coin and coins—used in the U.s. today is fiat money; it has no value other than its use as money. You lot will notice that statement printed on each neb: "This note is legal tender for all debts, public and private."

Checkable deposits, which are balances in checking accounts, and traveler's checks are other forms of money that take no intrinsic value. They tin be converted to currency, but generally they are not; they simply serve equally a medium of substitution. If you want to buy something, you tin often pay with a bank check or a debit carte. A check is a written order to a bank to transfer buying of a checkable deposit. A debit card is the electronic equivalent of a bank check. Suppose, for example, that y'all have $100 in your checking account and you write a check to your campus bookstore for $30 or instruct the clerk to swipe your debit card and "charge" it $30. In either case, $30 volition be transferred from your checking account to the bookstore'southward checking account. Discover that it is the checkable deposit, not the cheque or debit card, that is money. The cheque or debit carte du jour simply tells a bank to transfer money, in this instance checkable deposits, from one business relationship to another.

What makes something money is really found in its acceptability, not in whether or non it has intrinsic value or whether or non a government has declared information technology as such. For example, fiat money tends to be accepted so long as as well much of information technology is not printed as well chop-chop. When that happens, as information technology did in Russian federation in the 1990s, people tend to look for other items to serve equally money. In the case of Russia, the U.S. dollar became a popular form of money, even though the Russian government still declared the ruble to be its fiat money.

Heads Up!

The term money, as used past economists and throughout this book, has the very specific definition given in the text. People can concur avails in a diverseness of forms, from works of fine art to stock certificates to currency or checking business relationship balances. Fifty-fifty though individuals may be very wealthy, only when they are holding their assets in a form that serves every bit a medium of substitution do they, according to the precise pregnant of the term, have "money." To qualify equally "money," something must be widely accepted every bit a medium of exchange.

Measuring Money

The total quantity of money in the economy at whatever one time is called the money supply. Economists measure the coin supply because it affects economical activity. What should be included in the coin supply? We desire to include as part of the coin supply those things that serve as media of exchange. Even so, the items that provide this part accept varied over time.

Before 1980, the basic money supply was measured as the sum of currency in apportionment, traveler's checks, and checkable deposits. Currency serves the medium-of-substitution role very nicely only denies people whatsoever interest earnings. (Checking accounts did not earn interest before 1980.)

Over the terminal few decades, especially as a result of high involvement rates and high inflation in the late 1970s, people sought and found ways of holding their financial assets in ways that earn interest and that can easily be converted to money. For example, information technology is now possible to transfer money from your savings account to your checking account using an automated teller machine (ATM), then to withdraw cash from your checking account. Thus, many types of savings accounts are easily converted into currency.

Economists refer to the ease with which an asset can be converted into currency as the asset's liquidity. Currency itself is perfectly liquid; you can always change two $five bills for a $10 nib. Checkable deposits are almost perfectly liquid; you can easily cash a check or visit an ATM. An function building, however, is highly illiquid. It can exist converted to money just by selling it, a time-consuming and plush process.

As financial assets other than checkable deposits have become more liquid, economists have had to develop broader measures of money that would stand for to economic activity. In the United States, the final arbiter of what is and what is not measured as money is the Federal Reserve System. Considering information technology is hard to make up one's mind what (and what non) to measure as money, the Fed reports several different measures of money, including M1 and M2.

M1 is the narrowest of the Fed's money supply definitions. It includes currency in circulation, checkable deposits, and traveler's checks. M2 is a broader measure of the money supply than M1. It includes M1 and other deposits such equally pocket-sized savings accounts (less than $100,000), as well as accounts such as money marketplace mutual funds (MMMFs) that place limits on the number or the amounts of the checks that can exist written in a sure flow.

M2 is sometimes called the broadly divers coin supply, while M1 is the narrowly defined money supply. The assets in M1 may be regarded as perfectly liquid; the assets in M2 are highly liquid, simply somewhat less liquid than the avails in M1. Even broader measures of the coin supply include large time-deposits, money market mutual funds held past institutions, and other assets that are somewhat less liquid than those in M2. Figure 24.1 "The Two Ms: October 2010" shows the limerick of M1 and M2 in October 2010.

Figure 24.one The 2 Ms: October 2010

M1, the narrowest definition of the money supply, includes assets that are perfectly liquid. M2 provides a broader measure of the money supply and includes somewhat less liquid assets. Amounts stand for coin supply data in billions of dollars for October 2010, seasonally adjusted.

Source: Federal Reserve Statistical Release H.6, Tables 3 and 4 (December two, 2010). Amounts are in billions of dollars for Oct 2010, seasonally adjusted.

Heads Upwards!

Credit cards are not coin. A credit carte identifies you as a person who has a special arrangement with the bill of fare issuer in which the issuer volition lend you money and transfer the proceeds to another party whenever you want. Thus, if you present a MasterCard to a jeweler as payment for a $500 band, the firm that issued you the menu will lend you the $500 and send that money, less a service charge, to the jeweler. You, of course, will be required to repay the loan afterward. Merely a card that says you have such a human relationship is non coin, just every bit your debit card is not money.

With all the operational definitions of coin bachelor, which one should nosotros employ? Economists generally answer that question past asking another: Which mensurate of money is near closely related to real GDP and the price level? As that changes, so must the definition of money.

In 1980, the Fed decided that changes in the means people were managing their money fabricated M1 useless for policy choices. Indeed, the Fed now pays little attention to M2 either. Information technology has largely given up tracking a particular measure of the money supply. The choice of what to measure as money remains the subject field of standing research and considerable contend.

Key Takeaways

• Coin is anything that serves as a medium of substitution. Other functions of money are to serve as a unit of account and equally a store of value.
• Money may or may non take intrinsic value. Commodity money has intrinsic value considering it has other uses besides being a medium of exchange. Fiat money serves simply equally a medium of exchange, because its use as such is authorized by the government; information technology has no intrinsic value.
• The Fed reports several different measures of money, including M1 and M2.

Effort It!

Which of the following are money in the United states of america today and which are not? Explain your reasoning in terms of the functions of money.

1. Golden
2. A Van Gogh painting
3. A dime

Case in Point: Fiat-less Money

"We don't have a currency of our own," proclaimed Nerchivan Barzani, the Kurdish regional authorities'south prime number government minister in a news interview in 2003. But, fifty-fifty without official recognition by the regime, the and so-chosen "Swiss" dinar certainly seemed to function as a fiat coin. Here is how the Kurdish expanse of northern Iraq, during the catamenia between the Gulf War in 1991 and the fall of Saddam Hussein in 2003, came to have its own currency, despite the pronouncement of its prime minister to the reverse.

Afterward the Gulf War, the northern, more often than not Kurdish area of Republic of iraq was separated from the rest of Republic of iraq though the enforcement of the no-wing-zone. Because of United Nations sanctions that barred the Saddam Hussein regime in the due south from continuing to import currency from Switzerland, the fundamental bank of Iraq appear it would replace the "Swiss" dinars, so named because they had been printed in Switzerland, with locally printed currency, which became known as "Saddam" dinars. Iraqi citizens in southern Iraq were given three weeks to substitution their old dinars for the new ones. In the northern part of Iraq, citizens could not exchange their notes and and then they simply continued to use the onetime ones.

And so it was that the "Swiss" dinar for a period of about 10 years, fifty-fifty without government bankroll or any police establishing it every bit legal tender, served every bit northern Iraq'south fiat money. Economists employ the word "fiat," which in Latin ways "let it be done," to describe money that has no intrinsic value. Such forms of money usually get their value because a regime or authority has declared them to exist legal tender, only, as this story shows, it does not really require much "fiat" for a user-friendly, in-and-of-itself worthless, medium of exchange to evolve.

What happened to both the "Swiss" and "Saddam" dinars? After the Coalition Provisional Authority (CPA) assumed control of all of Iraq, Paul Bremer, then caput of the CPA, announced that a new Iraqi dinar would exist exchanged for both of the existing currencies over a iii-calendar month period ending in January 2004 at a rate that unsaid that 1 "Swiss" dinar was valued at 150 "Saddam" dinars. Considering Saddam Hussein'due south authorities had printed many more "Saddam" dinars over the 10-year flow, while no "Swiss" dinars had been printed, and because the cheap printing of the "Saddam" dinars fabricated them easy to counterfeit, over the decade the "Swiss" dinars became relatively more valuable and the substitution rate that Bremer offered nearly equalized the purchasing power of the ii currencies. For example, information technology took most 133 times as many "Saddam" dinars as "Swiss" dinars to buy a human's arrange in Iraq at the time. The new notes, sometimes called "Bremer" dinars, were printed in Britain and elsewhere and flown into Republic of iraq on 22 flights using Boeing 747s and other big aircraft. In both the northern and southern parts of Iraq, citizens turned in their one-time dinars for the new ones, suggesting at least more confidence at that moment in the "Bremer" dinar than in either the "Saddam" or "Swiss" dinars.

Sources: Mervyn A. Rex, "The Institutions of Budgetary Policy" (lecture, American Economics Association Annual Meeting, San Diego, January 4, 2004), available at http://www.bankofengland.co.uk/speeches/speech208.pdf. Hal R. Varian, "Paper Currency Tin can Take Value without Government Backing, only Such Backing Adds Essentially to Its Value," New York Times, January fifteen, 2004, p. C2.

Answer to Effort It! Problem

1. Gilt is not money because information technology is non used every bit a medium of exchange. In addition, it does not serve every bit a unit of account. It may, however, serve every bit a store of value.
2. A Van Gogh painting is non money. Information technology serves as a store of value. Information technology is highly illiquid just could eventually be converted to money. It is neither a medium of substitution nor a unit of account.
3. A dime is money and serves all three functions of coin. It is, of grade, perfectly liquid.

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Source: https://open.lib.umn.edu/principleseconomics/chapter/24-1-what-is-money/

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