Notes on Money (ECON 272)
Money is:
This section relates to IMPORTANT CONCEPT READING EIGHT: THE NATURE OF MONEY
However, money has more than just one function. The three functions of money are:
1.
2.
3.
NOBODY invented money. It is an institution that emerged spontaneously in order to make our lives easier.
Something is not considered a money until it is accepted by virtually everyone in a community when trading.
Commodity money is money that first emerged.
A commodity money will emerge
quickly due to the problems with barter (direct exchange):
1.
2.
3.
4.
The process of the emergence
of commodity money:
something that is very valuable (doesn’t matter why) in a particular
society will emerge as commodity money.
The process begins with some individuals realizing that if they have this one
valuable thing on hand, they can always (or almost always) use it to trade for
what they want from others (BECAUSE everyone in that society values this thing
so highly).
An imitation process begins -- people see others use this valuable
thing to get something else in exchange (instead of simply for its normal use)
and they see how convenient that is - and they copy the behavior.
So people start holding this good for both its use (use value) and for
trade (exchange value). The
key is that people know that they can always take this thing in exchange because
even if they don’t want it to use it at that time, they can always get rid of it
in trade (because it is so valuable to everyone) - hence it is acceptable to
people.
Eventually everyone catches on to this process (imitates the behavior)
and when everyone
is accepting it (and valuing it) in exchange, it is a commodity money.
Characteristics of a good commodity money:
Fiat Money, in a sense, sometimes emerged from commodity money:
Why do we use fiat money and not commodity money (most of the time)?
The process of the "emergence" of fiat money: fiat money is paper money (including coins that are not made of precious metals) - what makes it money is not its physical characteristics (as with commodity money) but the signature or legal stamp on the paper (usually defined as government law makes it money - but not always). The term "fiat" derives from the Latin ("let it be done", "it shall be").
Since gold and silver have the characteristics we want a good money to have – they were commodity money in many societies. A problem with commodity money is its portability. So people began storing the commodity in a storage facility and exchanging IOU notes which represented the commodity. Once everyone accepts these IOU’s in exchange, we have a
fully-backed fiat money (if the paper money is backed by gold, this is known as a "gold standard".) Each piece of paper represents a certain amount of a commodity.
The state can step in to this process (but not necessarily) – by putting a legal stamp on the paper -- but this can also be done by private banks. The problem is, once the state steps in, the typical story is that it wants more and more money – so it simply gradually removes the backing of the fiat money in order to be able to simply print more without having a commodity to back it up.
This is how we get to a
partially backed fiat money
and eventually a
non-backed fiat money.
Once we have a non-backed fiat
money, inflation often follows.