Money

Money is any medium of exchange. The crucial word here is “medium.” If I have eggs and you have bacon, we might agree to exchange a few eggs for several slices of bacon. But there’s no medium of exchange here. The exchange is direct, with real goods being exchanged for real goods. Thus we might say that the exchange is “immediate” — in other words, there’s nothing mediating the exchange.

By contrast, when money takes part in an exchange, it acts as a medium or intermediary to facilitate the exchange. Money, in many instances, acts as an instrumental good. That means it acts as an instrument to procure the real goods that we desire and that make a real difference to our lives. I can enjoy a $20 steak (a real good), but I can’t enjoy a $20 bill (an instrumental good) except for the benefit I can derive from it, such as by buying steaks.

But the distinction between real goods and instrumental goods is not hard and fast. Take cigarettes. In prisoner-of-war camps in WW2, cigarettes were used as money to purchase other items (bread, jam, butter). Used in this way, as a medium of exchange, the cigarettes served as instrumental goods. But a prisoner might also simply have wanted to enjoy a good smoke, In that case, the cigarette became a real good.

Gold and silver, which have an long history serving as money, share this same duality of being both real and instrumental goods. Thus gold and silver coins, in their capacity as money, constitute instrumental goods. But as, say, metals that can be made into jewelry, gold and silver constitute real goods.

For money be useful in facilitating exchange, it needs two features: it should be a unit of account and a store of value. Unit of account just means that we can do arithmetic and accounting with money. We can count it. We can divide it. And when we divide it into parts and then put the parts back together, we get back what we started with. As a unit of account, money is also fungible, which means that two items of the same amount of money are interchangeable. So, if you loan me a dollar bill and I pay back the loan with a different dollar bill, we are quit.

We also like to see money serve as a store of value, the point being that money has a certain purchasing power in the present and it should retain that power in the future. As a store of value, money should, ideally, be immune to inflation and deflation. We might think that only inflation undercuts a money’s ability of store value (as when a dollar buys tomorrow only half of what it buys today). But deflation is a problem as well for any form of money. If I’m a seller and the currency is deflating, then I’m losing money the longer I wait to sell.

Money comes in three traditional forms and one more recent form:

Commodity money: this is money that consists of physical stuff that has intrinsic value by being reasonably scarce. These moneys are not like air and water, which come in unlimited supplies. As commodities, they come with built-in limitations on proliferation. They are to varying degrees scarce, and their scarcity correlates with their value in exchange.

Redeemable money: This is money that gives you a claim on something of inherent value. Essentially, you can think of it as a receipt for commodity money and which allows you to redeem the receipt for a certain amount of the commodity.

Fiat money: This is money that comes into existence because the government or some other authority says it has value. It takes the form of coin or paper bills, and also as entries on bank ledgers.

Cryptocurrency: This untraditional form of money consists of cryptographic tokens transacted on a secured digital ledger (usually a blockchain) where the amount of the currency possible is strictly controlled (thus preventing proliferation of the sort that is always possible with fiat currencies).