What Money Is, and How It Is Different From Currency

Money-1

I’ve always thought money was a subjective topic.

Whenever I discuss money with people, it becomes apparent very quickly that we all have different associations with money. It means different things to different people. To some it means financial security. To others it may mean status. If for some it’s a means to buy things they want, to others it’s a means by which they can achieve some intangible things: like freedom, for instance.

I’ve always thought, therefore, that one can never have an agreeable chat about money with a person without first knowing what associations they have with money.

But recently, I’ve been doing some reading around monetary history and classical economics – both subjects which have never interested me so far until now – and was surprised to note one thing.

Money can be defined.

Not only that, it has been defined by people and philosophers throughout history.

What does this mean? It means that though the emotional effects of money are still personal, it is possible to have a calm, rational conversation about money with someone based on its fundamental definitions and features. It’s a bit like the darker emotions that we’ve discussed on these pages before. While I cannot say for sure how your envy (or anger or lust or greed) affects you versus how mine affects me, that shouldn’t stop us from sitting across the table from each other and discuss it, as if it were a scientific problem.

What can be used as money?

money-3 money-2

In one word: anything. Before human societies began minting coins, people used as a medium of exchange anything that the two parties agreed was precious. At various times, feathers, salt, seashells and colourful stones have been used as money. Say you’re a farmer and I a blacksmith. In exchange of your five bushels of rice, I may give you three feathers of a pigeon. Tomorrow, in exchange for my box of nails, you may pay me in two feathers. As long as you and I are convinced of the suitability of feathers as a medium of exchange, we can continue to use them as a medium of exchange.

After all, the things of value are the things that are being exchanged. Money doesn’t have to have any value by itself. At least in theory.

What’s wrong with barter?

barterBut if it is true that money doesn’t have to be a valuable item and that it only represents the value of the things that are being exchanged, why do we need it at all? If you’re a farmer and I a blacksmith, why can’t I just trade you some nails or hammers for a sack of rice?

I can, provided that you want hammers and nails and I want a sack of rice. We can only trade with one another if you have what I want and I have what you want. This is what is called the coincidence of wants.

Trade can quickly become cumbersome if we relied on barter alone, so we need something that represents the value of the commodities that are being exchanged.

What is good money?

aristotle

The grand old man of Greece, Aristotle, who seemed to have a finger in every pie, has one in this too. He defined the qualities of ‘good money’ in the following ways.

1. It must be durable. Money that fades or corrodes or changes form over time will not work as a medium of exchange. Of what use are the feathers that I gave you yesterday if they get broken by the wind tomorrow?

2. It must be portable. Money should be easily handled, and have high worth packed into small, pocket-sized units. This is one reason why we don’t use oil as money. It would be rather inconvenient lugging a barrel with you wherever you went.

3. It must be divisible. We should be able to break down money into smaller units, where each unit is indistinguishable in value from all the others. For example, a ten rupee note in your pocket is exactly the same, value-wise, as a ten rupee note in mine. Incidentally, this is one reason why we don’t use real estate as money: because no piece of land is exactly the same as any other.

4. It must be fungible. This basically means that one unit of money should be identical to any other unit. The two-rupee coin in your pocket buys as much – or as little – as the coin in mine.

5. It must be a store of value. This is perhaps the most important characteristic of all. Money should have intrinsic worth which stays the same over time. If you think of our trusted ten-rupee note, cast your mind back to your childhood and ask yourself how much ‘stuff’ it could buy. Does it have the same purchasing power today? If it doesn’t, can it be called ‘money’? If not, why do we insist on doing so?

The difference between currency and money

gold

I recently saw a video series that spoke about the difference between currency and money. In it, Mike Maloney, a cycles-investor, says that the pieces of paper we’ve come to use and know as money is not actually money. Why? Because it doesn’t have store of value. It loses purchasing power over time. So the most we can say about it is that it’s a unit of account and a medium of exchange, and therefore a currency.

As it turns out, there is one thing that has been used as money in almost every civilization of human history. It ticks all the boxes that ‘good money’ should. It gets a lot of bad press among investors as a dead metal that doesn’t earn anything. But it’s the perfect form of money.

Yes, that metal happens to be gold. We’ll talk more about gold in later posts, but here’s the full video for you to watch.

Images Courtesy: 1, 2, 3, 4, 5, 6


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