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The basic concepts of money

The history of money

Barter
The first people didn’t buy goods from other people with money. They used barter. Barter is the exchange of personal possessions of value for other goods that you want. This kind of exchange started at the beginning of humankind and is still used today. From 9,000-6,000 B.C., livestock was often used as a unit of exchange. Later, as agriculture developed, people used crops for barter. For example, I could ask another farmer to trade a pound of apples for a pound of bananas.

Shells
At about 1200 B.C. in China, shells became the first medium of exchange, or money. They have served as money throughout history even to the middle of this century. c.

First metal money
China, in 1,000 B.C., produced mock cowry shells at the end of the Stone Age. They can be thought of as the original development of metal currency. In addition, tools made of metal, like knives and spades, were also used in China as money. From these models, we developed today’s round coins that we use daily. The Chinese coins were usually made out of base metals which had holes in them so that you could put the coins together to make a chain.

Silver
At about 500 B.C., pieces of silver were the earliest coins. Eventually in time they took the appearance of today and were imprinted with numerous goods and emperors to mark their value. These coins were first shown in Lydia, or Turkey, during this time, but the methods were used over and over again, and further improved upon by the Greek, Persian, Macedonian, and Roman empires. Not like Chinese coins, which relied on base metals, these new coins were composed from scarce metals such as bronze, gold, and silver, which had a greater value.

Leather currency
In 118 B.C., banknotes in the form of leather money were used in China. Pieces of white deer skin edged in bright colours were exchanged for goods. This is believed to be the beginning of a kind of paper money.

Salt and spices
have been used as money. From 550 BC, accepting salt from a person was synonymous with receiving a salary, taking pay, or being in that person’s service. Definite indications are available that both black and white pepper have been used as commodity money for hundreds of years before Christ, and several centuries thereafter. Being a valuable commodity, pepper has naturally been used as payment.

Paper currency
From the ninth century to the fifteenth century A.D., in China, the first actual paper currency was used as money. Through this period the amount of currency increased causing inflation. Unfortunately, in 1455 the use of the currency disapeared in China. Chinese paper money did work well enough for a time. Marco Polo was impressed by the system during his visit to the Middle Kingdom. However, if there was a tendency to debase coins, the temptation to simply print more paper money regardless of the consequences was often irresistible, and public confidence in paper money was weak anyway. In 1294, paper money was forcibly introduced in Persia, but led to economic disaster. In the meantime, the first modern banks had been evolving. Moneylending and similar activities were essentially as old as money itself, and there were banks in Roman times, but they were more or less local affairs. The idea of a formal bureaucratic organization that spanned borders to handle savings, investment, and loans didn’t start in earnest until the 13th century. There were difficulties at first, with some early bankers burned at the stake, but by the 14th century Italian entrepreneurs were starting to make a go of the concept, the Medici family becoming the most famous of the lot. They used conventional metal currency, but conducted financial transactions using “bills of exchange”, which were documents obtained at a given price that specified a particular payment when presented. For example, in 1317 the Italian banking firm of Peruzzi and Bardi arranged the transfer of the monies collected from the churches of England to the Pope in Italy. The London office of Peruzzi and Bardi obtained the coinage and sent a bill of exchange to Rome, which was then redeemed to the Pope in coinage by the Rome office of the bank. The money changed hands without physically changing hands. Bills of exchange could also be transferred through many hands before they were redeemed. They weren’t exactly paper money, being something more like a modern money order, but they were close to paper money, and did much to grease the wheels of commerce.

Representative money
Banks issued a paper receipt to their depositors, indicating that the receipt was redeemable for whatever precious goods were being stored (usually gold or silver money). It didn’t take long before the receipts were traded as money, because everyone knew they were “as good as gold”. Representative paper money made possible the practice of fractional reserve banking, in which bankers would print receipts above and beyond the amount of acutal precious metal on deposit. So in this system, paper currency and non-precious coinage had a little value, but achieved significant market value by being backed by a promise to redeem it for a given weight of precious metal, such as silver. This is the origin of the term “British Pound” for instance; it was a unit of money backed by a Tower pound of sterling silver, hence the currency Pound Sterling. For much of the nineteenth and twentieth centuries, many currencies were based on representative money through use of the gold standard.

Gold standard
In 1816, England made gold a benchmark of value. This meant that the value of currency was a fixed weight of gold. This helped to prevent inflation of currency. The U.S. went on the gold standard in 1900,but because of the depression of the 1930′s, the U.S. began a world wide movement to end tying currency to gold. Today, few nations tie the value of their currency to the price of gold. Other government and financial institutions now try to control inflation.

Fiat money
refers to money that is not backed by reserves of another commodity. The money itself is given value by government fiat (Latin for “let it be done”) or decree, enforcing legal tender laws, previously known as “forced tender”, whereby debtors are legally relieved of the debt if they (offer to) pay it off in the government’s money. By law the refusal of “legal tender” money in favor of some other form of payment is illegal, and has at times in history (Rome under Diocletian, and post-revolutionary France during the collapse of the assignats) invoked the death penalty. An example of fiat money is the new, international currency, the Euro. Its introduction changed the face of money, superseding many of the world’s oldest currencies.

Today
At present, nations continue to change their currencies. For example, the U.S. has already changed its $100 and $20 banknotes. In Poland, in 1994 polish zloty was denominated, 10 000 of old złoty was denominated to 1 new złoty. Governments through history have often switched to forms of fiat money in times of need such as war, sometimes by suspending the service they provided of exchanging their money for gold, and other times by simply printing the money that they needed. m. TOMMOROW Tomorrow is already here. Electronic money (or digital cash) is already being exchanged over the Internet.

The characteristics of money

According to the definition, the money is a medium of exchange, which is authorized or adopted by a domestic or foreign government, and which also includes a monetary unit of account established by an intergovernmental organization or by agreement between two or more nations. More generally speaking, money is a medium of exchange, unit of account, and a store of value. Nowadays, money is commonly defined by its functions in economy. We can distinguish 3 general functions of it:

Medium of Exchange
This function means that money is accepted throughout the economy as payment for goods and services. Buyers get goods by giving up money. Sellers receive money when parting with their goods. This is, without question, the most important function of money. This is the function that makes money MONEY

Unit of Account
This function means that money is used to designate the prices of goods and services. Any item that is generally accepted as payment for goods and services is also the obvious choice for denominating the prices of those goods and services.

Store of Value
This function means that money can be used to purchase the same quantity of goods and services that provide the same consumption value, in the future as it can purchase today. Inflation is the primary nemesis for the ability of money to store value.

The features of money

To function as a money, the monetary item should possess a number of desirable features:

As a medium of exchange
- it should have liquidity
- be easily tradable
- have a low transaction cost
- be easily transportable
- it should be durable (money is often left in pockets through the wash. The Mexican 20 peso note is made of plastic for durability. Gold coins are often mixed with copper to improve durability)
- it should minimize contamination and contagion (unlike paper, silver, as well as platinum and titanium, is used as a anti-bacterial and anti-viral agent. This property of silver has been recognized and used for eating utensils)
As an unit of account
- it should be divisible into small units without destroying its value (precious metals can be coined from bars, or melted down into bars again. This is why leather or live animals are not suitable as money.)
- it should be fungible: that is, one unit or piece must be exactly equivalent to another (this is why diamonds, works of art or real estate are not suitable as money)
- it must have a specific weight, measure, and size to be verifiably countable. (for instance, coins are often made with ridges around the edges, so that any removal of material from the coin (lowering its commodity value) will be easy to detect)
As a store of value
- it should be long lasting, durable (food items, expensive spices etc., are not generally suitable as money)
- it should have a stable value
- it should be difficult to counterfeit (making imitations), and the genuine (authenticity) must be easily recognizable.
As anonymous
- money should not be subject to government tracking
- it should be useable for purchases in a black market
- it should not require equipment, tools or electricity to use.

The use of money provides an alternative to bartering, which is often considered to be inefficient because it requires a coincidence of wants between traders, and an agreement that these needs are of equal value, before a transaction can occur. The efficiency gains through the use of money are thought to encourage trade and the division of labour, in turn increasing productivity and wealth. In common usage, money refers more specifically to currency, particularly the many circulating currencies with legal tender status conferred by a national state

Measure of money supply

As we now, the purpose of Central Bank is to keep relatively stable level of prices. In a long period of time this level is affected by amount of money on the market ? the more money the higher price level and inflation, on the other side the less money are on the market, the lower price level is, which is also injurious. This is why the information about money supply, published by Central Bank is so important. Obviously, central bank controls the amount of banknotes and coins, which is emitted by it. But the total amount of money in the economy is much higher. The problem is, that the definition of money includes not only material cash but also everything, what is accepted as a payment for goods and services. Too bad, that this situation is also complicated by existence of commercial banks. During stabilization there’s no need to keep all the money in bank. Typically, an account provider will not hold the entire sum in reserve, but will loan the money out at interest to other clients, in a process known as fractional-reserve banking. That process will create a new deposit in a future and so on and so on. The reserve requirement, which bank must physically have in a moment is described by formula D = R/r, where r is cash reserve ratio, and R is the amount of primary deposit. Bank money created in that process will be several times higher than deposit was, and so this influences of money supply. The most common measures are named M0 (narrowest), M1, M2, and M3. M0: The narrowest concept of measure of money, which consist of all physical currency, plus accounts at the central bank which can be exchanged for physical currency.

M1: Includes M0 and also the amount in demand accounts of individuals, economic entities and non-banks financial institutions
M2: Includes M1 and savings accounts in commercial bank, which return date is not more than 2 years
M3: The widest concept of measuring money, consisted of M2 + all other deposits and repurchase agreements. What’s interesting is, that according to inflation report for February 2005 in Poland cash was only 13,7% of M3, while in euro zone this was about 6,9%