What Is Money? Definition, History, Types, and Creation

From barter, cattle, and cowrie shells, the world has come to modern coins and currency. And now, we can not imagine our lives without money. Let us see how it has evolved through time, what functions it performs and what is its future.

Money Defined

Simply put, money is any object or asset that individuals exchange as payment for goods and services or as a means of debt repayment. It enables individuals and businesses to obtain what they require to live and thrive. In other words, money is anything that can be used as a medium of exchange, and a medium of exchange is any payment method that is widely accepted.

Money has the advantage of being portable, as without money, all transactions would have to be done by barter. Since ancient times, the barter system has been the oldest form of business. Before the creation of monetary currency, people exchanged goods and services for one another, with the goods being transferred required to have value to both parties. Hence, money eliminates trade by barter and the need to transport heavy and perishable marketable items. Business is now infinitely simpler with the availability of paper money or smaller coins with standardized values and broad acceptance. Accepting cash, check deposits, debit cards, and credit cards give some importance to money.

Notably, the three essential qualities of money are the following:

• Acceptability. The general adoption of money is a crucial quality, as its acceptance is required for it to function as a medium of exchange.
• Legal tender status. The approval of money as a legal tender enhances its credibility, resulting in its acceptance under the law as a form of payment by individuals and organizations.
• Relative scarcity. This is another essential quality of money. Here, the laws of demand and supply are also applicable to money. The volume of economic transactions and the quantity of money people wish to save influence how much money is demanded. The amount of money supplied will determine the value of money if there is a constant level of demand.

History of Money

As said earlier, money is a means of payment, and a means of payment is anything accepted as a form of payment in a given jurisdiction. But what existed before the use of money as a means of payment? Shells, cowries, pearls, gold, furs, and even bones were once used as currency, but with the development of civilization, better alternatives have been created.

The shekel, which is regarded as the earliest kind of money ever discovered, was invented by the Mesopotamians as the first sort of money. Coins made of gold and silver first emerged between 650 and 600 B.C. during that time and were used to pay for soldiers. Coins made of metal dating to 1250 B.C. have been discovered.

Many different countries have used various special types of coins throughout history. Around 500 B.C., stamps of gods and emperors were used to authenticate the earliest round coins. The common coin in Western Europe from 794 to 1200 A.D. was the silver penny, which Charlemagne introduced in 800 A.D.

By the middle of the 13th century, the terms shilling and pound were frequently used to refer to larger amounts of pennies. As the value of money changed over time, more varied forms of currency were produced. Although the first paper money was produced in China between 700 and 800 A.D., it took centuries for it to become widely used. China was the first country to use paper money, though it was not widely used until around 1455. Because paper money was less cumbersome, it became possible to trade internationally, which presented opportunities and difficulties, including distrust and currency wars.

In 1816, England decided to use gold as its currency. Due to the fact that each banknote represented a certain amount of gold, only a limited number of banknotes could be produced. In today’s world, money can take many forms, from fiat currencies like the US Dollar, Nigerian Naira, or the Great Britain Pound to virtual currencies like Bitcoin (BTC). The invention of modern money has made purchasing, selling, and trading simpler than ever.

Functions of Money

Money performs the following functions:

• Medium of exchange. Money serves as a medium of exchange as it enables a complete transaction between a seller and a buyer.
• Store of value. Money serves as a store of value as it is an asset that may be invested in, saved in a bank, or kept in personal care with the expectation that it retains its value.
• The measure of value. Money can be used to measure the value of a good or service. Besides, money makes it simpler to compare the prices of seemingly unrelated items. For instance, the prices for an egg, an apple, and a gallon of fuel differ, with a gallon of fuel as the most expensive in this equation. In simpler terms, the amount of money paid for a product or service determines its value.
• Basis of credit. Money can be lent out since it can be used in making purchases. People would find it more challenging to make major purchases like houses and cars if all products or assets require full and instant payments. Hence, this gives room for mortgages, leases, and hire purchases.
• Unit of account. The value of the goods and services being exchanged can be measured consistently using money as a unit of account. The supplier and buyer can reach an agreement on the number of goods to be delivered and their prices.

Types of Money

In general, there are four types of money:

• Fiat money. Fiat money is legalized by the government, widely accepted as legal tender, and has no fixed value. Notably, fiat money is not backed by gold, silver, or other tangible assets.
• Commodity money. This type of money has its value pegged against the commodity from which it is derived. Their values and uses are embedded in them. Examples are precious metals (gold, silver, diamond, etc.), jewels, spices, and even coffee, which can be used as commodity money.
• Fiduciary money. This type of money is the currency that is available or in circulation in the economy. This is the available liquidity for the economic players to make transactions.
• Commercial bank money. This is money in the economy that commercial banks make as debt. In order to earn interest, banks lend money to other customers based on the fiat money their customers have deposited.

Measuring Money

Rather than attempting to define a single unit of measurement for money, economists provide broader definitions based on the concept of liquidity. Liquidity explains the swiftness of the purchasing power of goods and services. Economists employ M1, M2, and M3 measures of the money supply.

M1 represents the most liquid share of the money supply, comprising currency, savings deposits, demand deposits, and other liquid deposits. Simply put, M1 is cash or assets that can be swiftly converted to cash. Checkable deposits, also referred to as “demand deposits,” are closely tied to cash. As soon as a check is made or a debit card is used, the financial institution is required to deliver the depositor’s money “on demand.” This is why they are also known as demand deposits or checkable deposits. Currency and bank checking accounts make up the majority of M1 when combined. Although still included in M1, traveller’s checks have become less common in recent years.

Further, M2, which is a larger concept of money, adds additional sorts of deposits in addition to everything in M1. For instance, savings deposits in banks are included in M2, which are accounts on which you cannot write a check directly but from which you can quickly withdraw cash at an ATM or bank. Money market funds, in which the deposits of numerous individual investors are pooled together and invested in a secure manner, such as short-term government bonds, are another option offered by many banks and other financial organizations. Small-denomination certificates of deposit (CDs), also known as time deposits, are another component of M2. These are accounts that the depositor has agreed to leave in the bank for a specific amount of time, ranging from a few months to a few years, in exchange for a higher interest rate.

Finally, M3 is a measure of the money supply made up of large-time deposits, institutional money market funds, short-term repurchase agreements (known as repos), and more liquid assets, which also cover M2. The M3 measurement takes into account “near-money” assets, which are more closely related to the finances of larger financial institutions and corporations than to those of small businesses and individuals. Near-money assets are less liquid than other parts of the money supply and are included in the money supply measurement.

Modern Monetary Systems

A monetary system is a group of institutions, policies, and practices that control how money is produced, distributed, used, and regulated in an economy. It serves as the foundation for all economic activity and is essential to determining a country’s economic health.

In today’s world, the monetary systems of all the major nations are quite similar. They consist of three levels:

• The holders of money (the public) include people, businesses, and governmental entities.
• Commercial banks, private or government-owned, borrow from the public primarily by taking their deposits.
• Central banks, which have a monopoly on the issue of certain types of money, act as the bankers for the central government and the commercial banks and have the authority to create new money.

In addition, money is held by the general public in two different ways, which are cash (including coins) and bank deposits.

Modern monetary systems contribute to preserving a nation’s currency’s value by regulating the quantity and rate of money supply in circulation through tools like interest rates, taxes, and government spending plans. The monetary system also contributes to the stability of prices by preventing excessive levels of inflation and deflation, which occur when prices increase or decrease too quickly. Giving businesses the resources they need to develop and operate helps to balance economic activities and keeps companies from going bankrupt.

Bottom Line

Money is anything that has been legalized as a medium of exchange within a jurisdiction. And while money can be visible, it can also be invisible. Your investments, checks, bank deposits, and other assets that can not be immediately liquidated are all money, as much as fiat currencies. Interestingly, many countries have their own government-endorsed money used within and even for international trade. Performing numerous functions, money is a tool we need to live our lives.