Before we talk about Types of Money, let’s ask ourselves,
What is Money?
According to Investopedia, Here are the multifaceted characteristics of money:
- Money is a medium of exchange; it allows people to obtain what they need to live.
- Bartering was one way that people exchanged goods for other goods before money was created.
- Like gold and other precious metals, money has worth because for most people it represents something valuable.
- Fiat money is government-issued currency that is not backed by a physical commodity but by the stability of the issuing government.
- Above all, a money is a unit of account – a socially accepted standard unit with which things are priced.
Related Reading: Things To Sell To Make Money
Functions Of Money
Money is something we use every single day. We earn it, spend it, try and save it to pay off debt and think about it way more than we’d like!
Money is defined as any good that is widely accepted as a final payment for goods and/or services.
For example, strings of beads called Wampum was used as money by Native Americans and early American settlers.
A Medium Of Exchange
Money is a medium of exchange to facilitate transactions. This means that money is widely accepted as a method of payment.
If I go to get a haircut, I can be confident that my barber will accept my payment of money.
Fun fact, U.S. paper money carries a statement like this: “This note is legal tender for all debts, public and private. ”
This means that the government actually protects your right to pay with U.S. Dollars!
Without money, all transactions would have to be conducted by barter, which is the direct exchange of one good or service for another.
The difficulty with the barter system is that in order to obtain that particular good or service from the supplier, you have to have something of equal value, which the supplier also desires.
There needs to be a double coincidence of wants between the two parties which in all likelihood is probably not going to happen.
Storage Of Value
In order to be a medium of exchange, money must be able to hold its value over time, hence it must be a store of value.
If money couldn’t be stored for some period of time, it would not solve the double coincidence problem we talked about earlier and hence could not be adopted as a medium of exchange.
If we couldn’t store money, what would be the point in saving it!
However, money is not unique, there are many other stores of value that exist, some examples are:
- Works Of Art
- Baseball Cards
- Collectible Toys
Money might not even necessarily be the best store of value. That’s thanks to this little thing we call Inflation.
Inflation slowly erodes the value of your money over time and in turn decreases your purchasing power.
On the flip side though, money is more liquid than most other stores of value, it is readily accepted everywhere while also being very easy to transport.
Unit Of Account
Think of money as a device we use to measure value in economic transactions.
If you wanted to buy a new TV, the prices aren’t shown to you in the number of underwear that the TV will cost (wouldn’t that be something!).
It’s the most helpful when prices are set in terms of money because it is a common measure of value across economies.
It enables both the supplier as well as the purchaser to make informed decisions about how much to supply and how much of the good to purchase.
Various Types Of Money
Throughout history, there have been different forms of money from seashells, banknotes, debit cards and even cryptocurrencies.
At different times, multiple commodities were used as a medium of exchange.
So, we can say that according to the needs of the people, the kinds of money has changed.
Let’s talk about the most accepted types of money, which are:
Today, Fiat money is the basis of the entire modern money system. Examples of Fiat money are Bank notes and coins.
According to Merriam Webster, Fiat is defined as “an authoritative or arbitrary order”.
Fiat currency, is money which doesn’t have any intrinsic value and is based on an authoritative decision by a governing body.
If the government declares it as legal tender, then it must be accepted as a form of payment everywhere.
It is important for governmental bodies to control fiat money as it could affect the entire economy of a country if misused.
Commercial Bank Money
Commercial Bank Money are also called demand deposits.
An example of Commercial Bank Money is like when you have funds in a checking account.
These are claims against financial institutions that can be used for the purchase of goods and/or services.
This can be through the means of withdrawing in person, cashing checks, using ATMs etc.
This is a debt created currency by banks and they use this to create more money with a process called Fractional-Reserve Banking.
In fractional-reserve banking, only a certain portion of money the bank has is actually held within it.
The rest is given to people like you and I in the form of loans.
The bank ends up making back more money from the interest and other fees that they charge to their customers.
To summarize, the banks loan out the money that you deposit, give that to other people in the form of debt and create more money from the interest placed.
Examples of Commodity Money are precious metals like gold, silver etc.
It is the simplest kind of money where valuable resources would fulfill the functions of money.
The value of this kind of money comes from the value of resource and the scarcity of the resource.
Unlike Fiat money, this type of money has intrinsic value.
Unlike the barter system, commodity money served as a unit of account that allows you to compare the worth of goods and services.
Examples of Fiduciary Money are cheques and bank drafts.
Today’s money economy is highly fiduciary.
When a bank assures its customers that they can pay in different types of money and the customer can sell the promise or transfer it to somebody else, that is basically Fiduciary money.
It is derived from the Latin word Fiducia, which means “to trust”.
Characteristics of Money
Fiat, Commercial Bank, Commodity and Fiduciary money all share these common characteristics of money:
Even though t-shirts have intrinsic value, some people may not accept them as payment.
In contrast, people will be more than willing to accept a $10 bill as a method of payment.
The value must be easily identified. A $10 bill marked with a “10” for example.
Seeing and comparing its worth should be easy.
You don’t want to be going around paying $100 for a chocolate bar do you?!
Stability Of Value
We know that inflation is a thing, and a very REAL thing at that.
But one of the characteristics of money is that the value should be able to remain constant over a long period of time.
Even though inflation reduces your purchasing power, on the face value a $20 bill is still $20. Hence, money has some stability of value.
The material that is is made of should be capable of being beaten, melted and given convenient shapes.
It shouldn’t be too hard or too soft. Too hard would mean that it can’t be easily coined while too soft means it wouldn’t last as long.
It should be able to be carried around and transported across borders with relative ease.
Fiat money is considered to be extremely portable since you can transfer such large physical quantities at a time.
It should be able to be divided.
For example: A $20 can be divided into four $5s, which in turn can be divided into 20 $1s etc.
It must be able to withstand the wear and tear of the environment as well as going from one persons hand to the other.
I am surprised we don’t wash our hands as often as we should since money can be a carrier for a LOT of bacteria!
In order that a commodity can be used as a measure of value, it is vital that its units are similar in all respects.
This means that all units of the commodity used as money should be of the same quality, have equal weights and have exactly the same value.
Other Types Of Money
There are other types of money that are widely accepted as a medium of exchange in the settlement of debts.
These are symbols of money that might be legal tender.
They are generally accepted in certain areas that are restricted, it’s not widely accepted because they are often not completely backed up by the law.
Some examples include: vouchers for shopping and tickets.
Legal tender is a form of payment in which a person is forced to accept it by law as a settlement of debt.
It is generally regarded as an offense if you reject to pay.
Think about when you get a speeding ticket or a traffic violation fine.
Similar to Fiat Money, Representative money has no intrinsic value of its own.
It is backed by a commodity, hence it can be exchanged for precious metals like gold or silver that are held within a bank vault.
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Last Updated on 13th September 2022 by Emma