The financial system interconnects industries, governments and individuals around the globe. It steers money to them, diverts money away from them, intermediates between transactions, redistributes risk, and creates risk.
Our relationship with money leads us into a relationship with financial intermediaries – such as banks and funds – that offer us services in dealing with it.
What Is Money
Money is anything that acts as a store of value as it allows individuals to make choices on when to spend their purchasing power.
As the word money is used in everyday conversation, it can mean many things, but to economists, it has a very specific meaning.
To avoid confusion, we must clarify how economists’ use of the word money differs from conventional usage.
Economists define money as anything that is generally accepted in payment for goods or services or in the repayment of debts.
Currency, consisting of dollar bills and coins, clearly fits this definition and is one type of money.
When most people talk about money, they’re talking about currency (paper money and coins).
If, for example, someone comes up to you and says, “Your money or your life,” you should quickly hand over all your currency rather than ask, “What exactly do you mean by ‘money’?”
Basic Functions of Money
- Medium of Exchange: Money in the form of paper or coin is a medium of exchange, since in our economy people use it to buy goods and services. In a situation where there is no money we would live in a barter economy where goods and services were exchanged directly for other goods and services Money as a medium of exchange greatly simplifies the transactions which take place in an economy. The time spent trying to exchange goods or services is lowered and consequently transaction costs are reduced as well.
- Unit of Account: A second function of money is its serving as a unit of account. Unit of account means that money provides standardized terms in which prices are quoted and debts are recorded. With money, all prices, i.e. the values of goods and services, can be expressed in the same way, in terms of units of money. In the USA, for example, the unit of account is the U.S. Dollar. (Fiat Vs Cryptocurrency)
- Store of value: Money also functions as a store of value. This basically means that anybody in possession of money can decide to spend it in the future or store it, the generally serve a middleman service for those who want to store their money. People also hold an additional amount of money as a precaution against an unexpected need, e.g. a person might need some medicine immediately, because she or he suddenly feels ill.
Common Uses of Money Globally
- Payments services: She uses her bank to transfer money to others with bank accounts. She pays concert organizers for concert tickets. Other people pay her for music tutorials via their banks.
- Foreign exchange services: She takes a gap-year and purchases Mexican pesos from her bank with British pounds.
- Insurance: She buys travel insurance for her trip by paying a premium to an insurance company.
- Unsecured long-term credit: She returns from abroad, and decides to study, obtaining a student loan to pay for the tuition. She doesn’t own much, so can’t pledge collateral to secure the loan.
- Unsecured short-term credit: She starts working full time, and upgrades her account to include an overdraft facility. She also gets a credit card. Both of these are short-term loan facilities, allowing her to buy things she doesn’t have immediate money for.
- Savings and investment: In her late 20s she has extra cash. She wishes to invest it, putting some into a mutual fund that invests in company shares. Her employer also offers her a pension plan, paying part of her salary into a pension fund.
- Secured long-term credit: In her early 30s she borrows money to buy a house, obtaining a mortgage loan from a bank, which is secured on the house.
Brief Features of Money
In a sense, the value of money is determined by a coordination game among the participants of its ecosystem.
Since societies transitioned from a barter economy to using a money as a medium of exchange, individuals have tried to devise systems that allow for rational ways to exchange value.
In order to help make goods and services commensurable the Greek philosopher Aristotle came up with four criteria that help to dictate what is considered to be ‘good money’:
- It must be durable
- It must be portable
- It must be divisible
- It must have intrinsic value
Originally the preferred medium of exchange was gold as it was able to fulfill all four of these criteria. As economies grew and the demand for a medium of exchange increased, governments were forced to create a more accessible medium of exchange that they could control and regulate.
This was the birth of fiat currency. This particular medium of exchange has been adopted worldwide, however it has come with its own set of issues.