Money

People wishing to achieve their ends often have to trade. They can exchange their goods directly, if they have matching preferences and suitable goods, or indirectly, with the help of another good, the medium of exchange.

A commonly used medium of exchange is called money.

Medium of exchange and money

Jones can trade an apple against two eggs from Brown. But this direct exchange or barter limits the number of exchanges and the extent of social cooperation. Both must have a direct personal need for the goods of the other person and the goods must be easily divided. Using another, marketable good between the traded and desired goods and services helps to reduce some of the problems.

Indirect exchange means, "if, between the commodities and services, that are the ultimate end of exchanging, are one or several media of exchange."

A commodity that comes into general use as a medium of ex­change is money. The concept of a "medium of exchange" is precise. But at which point comes a medium of exchange into "common" or "gen­eral" use is not strictly definable, and whether or not a medium is a money can be decided only by historical inquiry and the judgment of the historian. However, for purposes of simplifica­tion, and since there is a great tendency on the market for a medium of exchange to become money, we shall refer to the media of exchange as moneys.

Origin and properties

In the history of mankind, a great variety of commodities — cattle, shells, nails, tobacco, cotton, copper, silver, gold, and so on—have been used as media of exchange. In the most developed societies, the precious metals have eventually been preferred to all other goods because of their physical characteristics (scarcity, durability, divisibility, distinct look and sound, homogeneity through space and time, malleability, and beauty).

For a good to become money, it must have the physical properties and be considered valuable by itself. The price of a good, when employed only for nonmonetary purposes, is a good starting point to estimate its price for use as a money. Should the good stop being money, it will still have value due its other uses.

Historically, there were often several types of money used concurrently and for different purposes. For example, silver tended to be widespread in daily use, while gold served for larger and international transactions. Livestock was for ages associated with wealth (and while it is bulky, it can be easily transported). The role of cigarettes in prisons is also well documented.

Money in the free market

The emergence of money happens through a gradual process, in the course of which more and more market participants, each for himself, decide to use one commodity rather than others in their indirect exchanges. Thus the historical selection of gold, silver, and copper was not made through some sort of a social contract or convention. Rather, it resulted from the spontaneous convergence of many individual choices, a convergence that was prompted through the objective physical characteristics of the precious metals. Money selected in the free market. i.e. money that comes into use by the voluntary cooperation of acting persons, is also called natural money.

Types

Commodity money

As the more marketable commodities in any society begin to be picked by individuals as media of exchange, their choices will quickly focus on the few most marketable commodities available. As the individuals center on a few selected commodities as the media of exchange, the demand for these commodities on the market greatly increases. For commodities, in so far as they are used as media, have an additional component in the demand for them-not only the demand for their direct use, but also a de­mand for their use as a medium of indirect exchange. This de­mand for their use as a medium is superimposed on the demand for their direct use, and this increase in the composite demand for the selected media greatly increases their marketability. Thus, if butter begins as one of the most marketable commodities and is therefore more and more chosen as a medium, this increase in the market demand for butter greatly increases the very market­ability that makes it useful as a medium in the first place. The process is cumulative, with the most marketable commodities becoming enormously more marketable and with this increase spurring their use as media of exchange. The process continues, with an ever-widening gap between the marketability of the medium and the other commodities, until finally one or two commodities are far more marketable than any others and are in general use as media of exchange.

Money substitutes

Or money certificates, are placeholders for actual money, that is stored in a bank and can be redeemed at any time by the present owner of the note. Instead of trading e.g. silver, people would trade with the notes. Apart from paper notes, the main types of such substitutes are token coins, certificates of deposit, checking accounts, credit cards, and electronic bank accounts on the Internet. The advantage are lower transaction costs, the downside is a greater potential for abuse (and historically, this lure appeared to be too great for anyone to escape).

Credit money

Credit money is created when financial instruments are used in indirect exchange. It is only a derived kind of money. It receives its value from an expected future redemption. For example, an IOU can be accepted by others, if they trust the reputation of the issuer of debt. This risk of default also limits its application.

"Not surprisingly, therefore, credit money has reached wider circulation only when the credit was denominated in terms of some commodity money, when the reputation of the issuer was beyond doubt, and when it was the only way to quickly provide the government with the funds needed to conduct large-scale war."

Fiat money

Often called paper money, fiat money is in a wider sense any money declared to be legal tender by government fiat. In a narrower sense used here, fiat money is an intrinsically useless good used as a means of payment and a storable object. All modern paper currencies are fiat money.

"In no period of human history has paper money spontaneously emerged on the free market. In all known historical cases, paper money has come into existence through government-sponsored breach of contract and other violations of private-property rights."

There are many reported advantages to fiat money as opposed to commodity-based money, among them:

• much lower costs of production
• the quantity can be easily modified to suit the needs of trade
• the quantity can be easily modified to stabilize the value of the money unit.

The main risk of this money is the possibility of a complete loss of value. See also For and against fiat money.

Under a fiat money standard, governments (or their central banks) may obligate themselves to bail out, with increased issues of standard money, any bank or any major bank in distress. In the late nineteenth century, the principle became accepted that the central bank must act as the “lender of last resort,” which will lend money freely to banks threatened with failure. Another recent American device to abolish the confidence limitation on bank credit is “deposit insurance,” whereby the government guar­antees to furnish paper money to redeem the banks’ demand li­abilities. These and similar devices remove the market brakes on rampant credit expansion.

See also History of fiat money in the USA.

Production of money

The production of additional units of money will decrease the value of already existing units. Those owning these additional units will tend to pay more money for goods and services or demand additional goods and services, and demand in turn more money when selling their own goods and services. Thusly, the production of money has a tendency to raise money prices, starting from the producers of money and spreading to other economical actors.

In the free market, the amount of money produced depends in the free market on the consumers. They decide not only the amount of goods (or money) to be produced, but also the the types of money widely used. Historically, coins of several metals and alloys were used concurrently, this appears to be the natural state of things.

It is often asserted, that higher money prices benefit debtors, as it lowers the relative value of their debts. This may not always be the case: if the lender's estimate of the rising prices is too high, the debtor may end up paying more an account of the expected inflation.

The final and possibly most important effect of a rising money supply is in its timing - the positive effect of "having more money" benefits the producer of money and those getting it first; while the negative effects impact the latecomers. This redistribution of of wealth and rising prices may be limited to some degree, but cannot be avoided.

External links

• Murray N. Rothbard, Man, Economy and State, esp. Chapters 2 and 3
• Ludwig von Mises, Human Action, esp. Chapter XVII
• Wikipedia page on money
• Frank A. Fetter, Economics In Two Volumes: Volume II. Modern Economic Problems