What money is and does
Money, somewhat like an airplane, is marvelous when it works well, frustrating when immobilized, and tragic when it crashes. Money is indeed one of man's greatest inventions- or developments, it has evolved over untold centuries. Men use money, as they do many things, with only vague notions of what it really is or how a monetary system functions. This day-to-day use may not require understanding of monetary theory. But management of an economy's money does require such understanding.
Defining money requires extensive discussion. Money is anything generally accepted in exchange or in the payment of debt. Currency- paper and coins- is, of course, money. The bulk of our money, in fact, consists of deposits in checking accounts.
One thing about money is obvious. Although money is used, it is not “used up” as it moves from hand to hand. The same money goes from person to person, year after year. Goods and services are produced and consumed. They are used up. Money flows through the economy without, for the most part, being destroyed and then replaced as it is used.
As far as history is concerned, men have used dozens of commodities as money. One author found 170 materials and objects that have served as money- for example oxen, tea, beer, stones, slaves, skins, yarn, shark teeth, tiger claws, furs, wine, and tobacco. All have been abandoned, because they proved unsatisfactory. Non-uniformity of money among colonies hampered trade. Transportation was difficult; if large amounts were involved, movement might be impossible. Fire and water could do great damage. There was another problem: living things may die from disease or age, as well as disappear in consumption. The advantages of metals over other commodities appeared in ancient times. Metals were durable, they wore out slowly. Storage required small effort. Coins became almost synonymous with money.
Money and economic life
Money is interwoven with almost all of our personal life and as well it touches all aspects of the functioning economy. More than that money is the intermediary or means by which people transmit most decisions about production, consumption, and the vast majority of economic matters.
Money is part of the framework of the economy. `Cranks' and even devoted specialists may exaggerate the importance of money. Creating goods and services, for example, produces real income, i.e., the things which satisfy human wants. Creating money, however, does not produce real things. The most sweeping monetary reform will not itself build houses or solve the problems of poverty.
On the other hand, seriously defective monetary policy, such as governmental actions greatly increasing or reducing the quantity of money, can lead to economic chaos that spreads through family, social, religious, and business life. The disruption can produce sweeping and terrible effects beyond the ability of most people to imagine. Disastrous monetary policies have involved mammoth inflations.
Why seek to understand monetary affairs?
Cannot the public leave to skilled “mechanics of money” the job of maintaining the monetary system in good working order? Most people do so, or think they do, just as they leave aircraft maintenance to technicians. Inevitably, however, the managing of money is influenced by government. And all voters have something to say, not only about who shall act as government officials in Congress and the Executive branch; voters also influence the monetary policies which these officials adopt. We may say, then, that monetary policy which affects everyone is made to some extent by ordinary people. Few, unfortunately, are qualified for such responsibility.
Most voters are not even competent to decide who are the monetary experts, to say nothing of what is the wisest policy. We can deal with many other technical matters in a strikingly different way, relying for example upon experts selected by scientific tests to keep airplanes in good order. We can avoid risk of air crashes by the alternative of using land transport. No one, however, can escape the disruption which results from folly, stupidity, or mere ineptitude in selecting and implementing monetary policies. All of us may suffer needless distress because of the monetary decisions of non-experts- voters seduced by glamorous visions of monetary ease, or elected officials insisting upon monetary stringency when business is sluggish. Much as one might want to leave national money management to experts, complete delegation is impossible where the masses vote. (Dictators find control over money to be the one of the more powerful weapons for dominating the public.) Not only the broad duties of citizenship but also the personal concerns of self-interest require that as many modern men and women as possible understand the monetary system. Self-interest is twofold- to formulate wise policies for everyone, and to adjust personal and business affairs to whatever does develop, good or bad.
Some aspects of money's influence may seem clear. Courses in economic principles show something about the ways by which money affects economic life. We learn how specialization and the division of labor depend upon a medium of exchange which frees us from the unimaginably confining limits of barter; how monetary mismanagement may create unemployment or inflation; how avoidable frictions in financing business may hinder economic growth. Principles courses also show what sometimes seems a mystery- how banks affect employment and price levels.
The varied purposes which money serves
For decades economists have distinguished four functions of money. The fourfold classification does help one to understand what money is and the varied ways in which it serves us.
Unit of account
Life requires us to keep count of many things, including values. Counting requires units in which to count. The dollar is one such unit. In this sense it is abstract, as is the inch, pound, minute, or quart. No one ever saw or felt the dollar or the minute as a unit of account, but we employ them constantly in measuring. The use of dollar in this sense is to help us quantify.
The quantities which we measure are values or worth. Bread and vegetables, houses and vacations, guns and butter, are widely different in physical characteristics. Yet they have in common something we call value. Values are bigger and smaller, more or less; they involve amounts. To be able to measure these amounts is highly desirable indeed. If the unit or basis of measure is common to all, the values can be compared quickly. Hence money functioning in its role as the unit of account is sometimes termed “the standard of value”.
The element counted, measured, or compared- worth- is expressed as price. The unit of account, in fact, is the thing (or concept) in which prices are quoted. Being able to express the worth, and the changes in worth, of myriads of goods and services in a common term- dollars- permits easy comparison. And comparisons are essential for exchange. A unit of account is indispensable. It helps businesses and families guide their decisions.
Medium of exchange
Money serves as a medium of exchange- such a characteristic is the necessary requirement emphasized in the definition of money. In exchange of our services, the employer gives us money. We then exchange them for shoes and lunches and hundreds of other goods or services. The ability to use money frees us from the need to barter- to make exchanges in the form of things for things. We can get bread or electricity without searching out each person in the long chain of production, finding what specific service he wants. With money, each complete exchange of goods or services can be separated into two independent parts: one item is exchanged for money, and then that money is used to buy something else. Each part can be handled as a transaction distinct from the other, but with a common element, money.
Exchange is possible if people will accept what others offer. Money differs from all other things in the extent of its acceptability. It will almost always be taken in exchange, for anything. We are confident that others in turn will accept money, and will do it without question.
Store of value
The transactions for which money serves so well as a medium of exchange do not as a rule take place instantaneously. Ordinarily, a family receives dollars one day and pays them out over days or weeks. For a time, it holds purchasing power. There is confidence that it will be accepted in the future. As a result money can serve as a store of value. Money gives those who hold it economic freedom through time. The holding of money is also the holding of an option on what to buy.
A wise person or business will hold money as a sort of insurance. It is a store of value to be used, not so much for expected purchases as for the unforeseen. But there is a disadvantage of not using money- it brings no income while being held. A house or a bond or business will provide services, bring in rent or interest, or help earn profit.
Standard of deferred payment
This function follows from the others. We need something to serve as a standard of payments to be made in the future. What if the only basis for making long-term contracts were in terms of physical things? Then arranging for the future would be stupendously difficult. For example, houses, machines, and most other physical objects change as they are used. Rarely can a person use something, especially over a period of years, and then return it in the exact original condition. Moreover, someone having specific things today, or the money to buy them, may not want the same items in the future. He will, of course want something later, but frequently not the physical thing. And in a progressive society tangible things which are highly desirable at one time often become outmoded.
Money is used to help tie together the present and the future in a definite, understandable, and indispensable way.
Qualities of good money
First of all, it is good when it is divisible by ten. Then it is easy to calculate.
Coins and pieces of paper ought to be convenient in size and shape, durable, quickly recognized, hard to counterfeit and easily transferable. The economy also needs safe, convenient, and inexpensive arrangements for handling money- currency and bank deposits.