Money's true identity: Delving into the origins and progression

What Is Money?

In the history of the world, as humanity evolved, so did money. The need for money arose as the need to trade did. Money has been and is used to communicate the prices of goods and services in numbers and store their value for a longer period. Money can be anything that has actual value by itself or a presentation of the value. For instance, the American 50-cent coin is made of metal, although it is valued to be of merely 50 cents its intrinsic value or actual value is worth much more since it is made of metal. Likewise, for paper currency, although the intrinsic value of paper is worth much less than metal, a $10 note is valued to be far more than a 50-cent coin.

In essence, money is the value people assign to a commodity that is accepted by a masses. Now that digitization is taking over the traditional monetary system, the valuation of money has been digitized, its form can now be found to be intangible – not coins nor notes, and with the rise of digitization a breakthrough technology of blockchain has come about, and with that cryptocurrencies have come to existence. Nevertheless, money exists in various forms be it in the form of legal tenders, fiat money, or even electronic, for any object to be considered money, it must have the following characteristics:

• Durable
• Divisible
• Portable
• Resistant to counterfeiting
• Liquid
• A unit of account
• Legal tender

Money is a unit that mainly acts as a medium of exchange in all economies. Every economy has its own money, more commonly referred to as currency. In the USA it is the American dollar, in Japan it is Yen and in the Philippines, the currency is the Philippine Peso among some of the currencies around the globe. Economies run on these currencies or money, as the saying goes, money makes the world go around.

Money has been one of the ties that has brought together countries. Historical trade routes that connected nations around the globe, it can be said that money is a form of communication. It can also be said that money enforces control in an individual economy or the global economy as a whole, as governments around the world have used money to enforce rules and laws. To elaborate, fines and penalties are implemented to control crimes. In the same manner, governments are responsible for minting their money, by this, it means, governments can control the flow of their currency and money that enters and exits the economy.

Function Of Money

The functions of money are:

1. Medium of Exchange

Money must facilitate transactions, as it is a generally accepted form of payment for direct exchange of goods and services.

2. Store of value

Money can be held for long periods, it can be held and exchanged in the future without losing much value.

3. Unit of account

Money provides a common measure of what goods and services are valued when exchanged. Knowing the value of the commodity enables both the buyer and seller to make decisions.

Evolution of Money

1. Barter Exchange

An actual form of money did not always exist in the history of humanity. From records, it is said “money” has existed for the past 3000 years or so. In the past, humans traded in a system famously known as the “Barter Exchange”. This negotiation-based system involved people exchanging a good or service for another commodity. This system prevailed for many centuries until the concept of money was introduced. For a person to partake in bartering, the participants had to make an arrangement to trade a pair of leather shoes with half a sack of rice. The same could be done for services, one could go to a teacher in exchange for some apples. Although this form of trade is the oldest, it was not free of shortcomings. For barter exchange to occur, double coincidence was necessary. This actively demonstrated that exchanges or trade could take place only if one of the participating parties offered and the other party accepted. Also, it was difficult to exchange commodities as their value would vary as the offered commodity varied. Therefore, there were numerous values/prices for a single product.

2. China’s Bronze Miniatures

Later in history, around 770 B.C. the use of actual objects that resembled the money we now recognize was seen in China. The Chinese miniature versions of weapons such as daggers, arrows, and spades were made of bronze, but this was abandoned, and circular bronze objects, which we now know as coins, were opted.

3. Lydia Minting Currency

Although it is believed China was the first to create “coins”, an area of Europe known as Lydia (at present it is western Turkey) was the first to manufacture coins industrially. The coins were made from a mixture of gold and silver, on which pictures were stamped on. The pictures determined the denominations of the value of the coins. With Lydia’s currency, the country increased internal and external trade, which made it one of the richest nations in Asia at the time. Soon, other nations followed on Lydia’s path of success, and hence the money-minting we now know began.

4. Paper Currency

China had been using paper currency when Marco Polo, a Venetian Explorer, traveled to Asia through the Silk Route in a period between 1217 and 1295. Banks in Europe eventually began to use paper money for depositors and borrowers instead of metal coins, as they were convenient and portable. The bank facilitated the paper currency to be exchanged or converted to gold and silver based on the face value of the paper money. However, unlike now, the banks issued paper money in the past, not the government.

Later in time history, America began minting paper currency, the “Greenback” during the American Civil War. They were legal tender and traded with IOU papers or the “I Owe You” papers, but were not backed by gold or silver, only the credibility of the U.S. government. The reason behind issuing IOU papers as the Colonial government often ran out of money during their operation since shipping coins and metals from Europe took a long time.

5. Currency War

When the world shifted to paper money, money could be produced more quickly. The time spent on mining metals, processing the metal, and turning them into coins was now lowered to printing paper money, which meant money could now be produced much faster than before. Significantly, Europe began to increase its amount of trade globally. Banks also began to purchase currencies of other nations and like so the market for currency trade came into existence. As time progressed, the value of currencies came into the realm of currency valuation in the international currency market. The stability of the monarchy or the government often determined the value of the currency and its ability to trade in the international market. Hence the competition among currencies began. Countries tried to change the value of their currency and mostly, they tried to change the value of their competitor’s currency by making the good of the competitor seem expensive, which would reduce the buying power and ability to purchase weapons and ammunition in war. Countries even went to the extent of complete extermination of their enemy’s currency too.

6. Electronic Payment

Now that we have entered an era post wars, most nations are now at peace, although all nations in the world are not as fortunate, nations are now tied together by the internet. As we know, money also tires the globe together, when the internet and money came together, mobile payments and cryptocurrencies came to exist. We have entered the age of technology, every person on earth has access to a device and has access to the internet. Now money has been digitized which allows all global citizens to make payments through portable devices such as cell phones, smartphones, tablets or laptops. Mobile payment services are rendered by platforms such as Google Pay, mobile banking apps, etc.

7. Cryptocurrency

Cryptocurrencies have come into existence in the last two decades. Cryptocurrencies have taken by storm since Bitcoin was created and within 12 years of its creation, 1,600 digital currency have been created. These 1,600 cryptocurrencies have been making spectators hold their breaths as to what the future may hold. Cryptocurrency goes beyond the traditional trade system, it eliminates middlemen in financial transactions that limit and control payment and trade. Cryptocurrencies are operated by decentralized authorities, not governments. Due to this, many governments around the globe are against it, while some have accepted it. Cryptocurrency is still a new concept for the globe which is at its initial stages it is yet to evolve.

Creation of Money

 1. Central Banks

A central bank in every nation is responsible for overseeing the monetary system and its monetary policy. It regulates the money supply in the economy, sets the nation’s interest rates, maintains price stability, and keeps commercial banks and other BFIs in check. Central banks create money. The government does not create money, but with the help of the Central Bank, the government can finance itself through money creation. The government can issue bonds and ask central banks to purchase them, the payment then creates money which the government can use to inject into the economy.

2. Open Market Operations (OMO)

OMOs are concerned with the purchase and sale of securities in the open market organized by the central bank. These markets essentially swap a financial asset for another. For instance, when the central bank purchases bond from banks or the public, bank reserves increase while the supply of money held by the people and banks decreases. In this way, the money supply in the economy grows.

3. Monetary Policy

The monetary policy manages the short-term interest rates in an economy and subsequently controls the cost and availability of credit in the economy. This impacts the overall economic activities. Since the central banks formulate and control the monetary policy, it can be said that the central bank is responsible for controlling credit in the economy. The central bank uses OMOs to purchase debts resulting in “monetary easing” which increases the bank's reserves, this creates money in the economy and this raises the process of those financial assets and lowers their yield. A process known as Quantitative Easing is also used to create money, it is an extraordinary form of monetary easing that stimulates the economy by increasing liquidity and encourages bank lending.

4. Government Spending

The government’s spending is dictated by the fiscal policy a nation produces every year. When a nation needs to spend more than what it has received from its revenues, it has to borrow, which is known as “Deficit Financing”. Deficit financing increases the money supply in the economy. This kind of money creation is highly disputed, as economists view this as an inflationary method of finance.

5. Banking System- Fractional Reserve Banking

Banks are required to hold cash at all times if depositors do withdraw cash. However, banks can’t return the entire amount, they have to retain a portion of the deposit which are known as reserves. This is done to expand the economy by keeping/maintaining capital for lending purposes. The banking system of fractional reserve is used as a tool by the central bank to implement the monetary policy. When the reserve requirements are increased, it reduces the money available in the economy while decreasing reserve requirements increases liquidity in an economy. This banking system puts an economic phenomenon into action, known as the “multiplier effect”. The multiplier effect multiplies the initial deposit and hence money is created in the economy.

Measurement of Money Supply

Money creation and money supply are closely tied together. Money supply can be referred to as all the cash, deposit, and currency circulation in the economy. Money supply can be classified based on the type and size of the account in which the instrument is kept. It reflects the liquidity in the economy and can be classified as:

M1

M1 money supply includes the cons and currency that are in circulation in the economy. M1 is also referred to as “narrow money”. This does not involve the money held by the treasury, banks, or the central bank. In other words, they are the amounts held in checking accounts, also called demand deposits. They are called so, as BFIs must return the deposits when demanded.

M2

M2 provides a broader definition of money. It includes saving deposits in addition to everything included in M1. BFI offers opportunities to invest in market funds to depositors. Depositors are pooled together and get a chance to invest in short-term government securities. M2 also involves certificates of deposit (CD) which are accounts that depositors can commit to when leaving deposits in banks for a few months or a few years in exchange for high interest rates. Essentially, M2 includes all money supply that can be spent and withdrawn but requires additional effort to do so in comparison to M1.

M3

M3 includes all money supply from M2 in addition to large time deposits, short-term repo (repurchase agreement), money market funds from institutions, and large liquid assets. The assets in M3 are less liquid than the other money supply measures and are also referred to as “Near money”. This implies that these components are closer to the finances of BFIs and corporations than small businesses and individuals.