# What is money?



## PaulHoughton (9 Aug 2009)

As this site is called askaboutmoney I want to ask a basic quuestion.

*What is money?*

Far more money is on deposit in banks than in paper form. This money exists as entries in a bank's database. 

The database stores the entries as tiny magnetic patterns on ferrous disks.  Copies of this pattern are made regularly and saved on magnetic tape. When the clerk wants to look at a customer's balance, a copy of the pattern on disk is transposed to a different pattern of charged capacitors in a computer's volatile memory. The computer communicates this pattern of charges to make a human readable display on the clerk's terminal.

This isn't really money, though is it? 

Money seems to be an idea: a memory that somebody did something for somebody for an agreed amount of units of exchange.

If my bank clerk takes a fancy to me and types in 1 million into my account, has this money been created? It won't reconcile, you say. Somebody will measure the deposits recorded against the incoming forms of payment and notice a discrepancy. Well what if a programmer in the bank changes the reconciliation program to ignore the discrepancy?

If I decide my house is worth a million euro and everyone on my street decides the same thing and we swap houses with each other, are we all then millionaires?

Are ideas and memories not precarious and delicate? If people stopped believing in money would it evaporate in the same way that past religions and memories are gone? 

So you fixed someone's plumbing and now you want me to give you some food in return. Well why should I?

What on earth is money?

What is to stop me creating my own currency? 

In a hypothetical, isolated society, if I am the ruler, then how much fiat money should I print?


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## sparkeee (9 Aug 2009)

cause i'll rip your plumbing back out.


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## Protocol (9 Aug 2009)

*What is money?*

Not an easy question to answer.
Money is the stock of assets that can be readily used to make transactions.

*Functions of money*
“Money is what money does”, meaning that money is defined by its *functions*:
1 A *medium of exchange*
2 A unit of account (otherwise thousands of relative prices)
3 A store of value and a standard of deferred payment

This last function means that money can be used to transfer wealth into the future and is also used as a benchmark when writing debt contracts.



*Types of Money*
Fiat money, commodity money.

*Controlling the quantity of money*
The CB has the legal monopoly in controlling the money supply (MS).
One instrument they use is open-market operations.

*Measuring the quantity of money*

As it’s not easy to define exactly what money is, then it is also difficult to measure the quantity of money.

*Currency* is obviously a form of money. However, many transactions are undertaken via bank deposits, so this is also included. The common point here is that these assets pay no interest.
*Current* or demand accounts (*not* savings accounts)
*Deposit*, or savings, accounts
Note that the US may define monetary aggregates differently to the ECB.

*General definitions:*
1 M1 = currency in circulation + overnight deposits (current account balances)
2 M2/3 = M1 + savings deposits at financial institutions

Beyond these definitions, different countries measure the stock of money in various ways. See the ECB definition, below:
*M1  = *A “narrow” monetary aggregate that comprises currency in circulation and overnight deposits. 

*M2 = *An "intermediate" monetary aggregate that comprises M1 plus deposits with an agreed maturity of up to two years and deposits redeemable at notice of up to three months. 

*M3 = **A “broad” monetary aggregate that comprises M2 plus repurchase agreements, money market fund shares and units as well as debt securities with a maturity of up to two years. *

*Some Irish data: (End-November 2008)*

*M1 = currency in circulation (€8,141m) + current a/c balances (€73,678bn) = €81,819m (€82bn)*

*M2 = M1 (€81,819m) + deposit a/c balances (approx. €115bn) = €197,131m (€197bn+)*


*A Dominated Asset*

Note the trade-off between *liquidity* and *yield* (or return). More liquid, less return. Money is said to be a *dominated* asset, in that for the same level of risk you could hold your wealth in a form that delivers a greater return, i.e. short-term Govt bonds.
This is the cost of holding a “liquid asset”.


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## PaulHoughton (9 Aug 2009)

Protocol said:


> Money is the stock of assets that can be readily used to make transactions.


What, like gold bars or commodities or houses? That's not money: those are physical objects. I might have loads of money but no physical assets. 


Protocol said:


> “Money is what money does”, meaning that money is defined by its *functions*:


If you asked me to define a car I wouldn't define it solely in terms of what it does, i'd tell you what it is. 

'um, it's a means of transport and it gets you there faster than a horse and people buy and sell them and you need to insure them' instead I would say that it is a machine with wheels and and engine and seats, a steering system, a transmission and so on. I could describe a car without going into its uses.

So what is money? I am not asking what money is used for.


Protocol said:


> 1 A *medium of exchange*


This is like saying a car is a means of transport. Doesn't tell you much about what a car is.


Protocol said:


> 2 A unit of account ..,A store of value and a standard of deferred payment


 more uses but no definition. I still don't get it.


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## Padraigb (9 Aug 2009)

PaulHoughton said:


> ... I still don't get it.



That's a problem many of have with money: we don't get it.


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## Protocol (9 Aug 2009)

PaulHoughton said:


> What, like gold bars or commodities or houses? That's not money: those are physical objects. I might have loads of money but no physical assets.
> 
> *Yes, gold was a form of money in the past, i.e. gold coins.*
> 
> ...


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## sparkeee (9 Aug 2009)

i doa job for you,you give me a loaf milk a head of cabbage and 5 tins of beans,i get a taxi out that night i give the taxi man  the loaf and 4 tins of beans,he stops to get some ciggies he gives the shop keeper 2 tins of beans and the loaf,to save all the mess we use currency instead,whats so hard to understand?


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## Protocol (9 Aug 2009)

Yes, barter is very awkward and inconvenient.

So money was developed to get around these problems.


NB: currency is only one form of money.  Most money is not in cash form.


Indeed, I have been thinking recently that we should move to a cashless economy. (Note: there would still be money, but no cash)


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## ollie323 (9 Aug 2009)

Then we really will have nothing. At least i can have a few notes in my wallet and they have some purchasing power. 
I'm not comfortable with a cashless system. Not to mention how easy it is to spend your earnings in cashless form. At least with cash, i'd have to go to a cash machine and then go buy whatever it was. All the while looking at my hard earned being handed over. Now it's just a case of entering my PIN and off I go with my impulse buy!


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## Duke of Marmalade (10 Aug 2009)

In today's developed economies money takes the form of transferrable IOUs drawn on society. Or more precisely IOUs drawn on the banking system which intermediates society's credit. In the case of retail banks these IOUs are entries in a current account, in the case of the Central Bank they are notes and coin.

These IOUs have no intrinsic value but rely on the price level when you seek to cash them in for goods and services. Over the longer term society does tend to welsh on these IOUs through inflation but in a functioning economy there is enough short run price stability for people to accept the IOUs as money.

The banking system/government could try to give the IOUs intrinsic value by say guaranteeing the price level for gold, say, or the price level for toilet rolls. But this is not necessary these days and brings with it its own significant problems.

If a bank clerk adds a few 0's onto your account, yes she has created money. That's what banks do, they create money. The equity of the bank will fall and as it must meet certain capital ratios there is a limit to the creation of money in this way.


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## Padraigb (10 Aug 2009)

Duke of Marmalade said:


> ... The banking system/government could try to give the IOUs intrinsic value by say guaranteeing the price level for gold...



That's one of the great myths. What gives gold its supposed intrinsic value? While gold does have some value for certain technical applications and as an ornamental material, its exchange price is mostly due to the fact that it is perceived to be useful as a medium of exchange and a store of wealth. In other words, a social understanding rather like that on which we ascribe value to particular bits of paper or base metal, or to entries in bank accounts.


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## Superman (10 Aug 2009)

Padraigb said:


> That's one of the great myths. What gives gold its supposed intrinsic value? While gold does have some value for certain technical applications and as an ornamental material, its exchange price is mostly due to the fact that it is perceived to be useful as a medium of exchange and a store of wealth. In other words, a social understanding rather like that on which we ascribe value to particular bits of paper or base metal, or to entries in bank accounts.



except that it is more difficult for some guy down the road to print more of it.


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## losttheplot (10 Aug 2009)

Is a currency based on the amount of gold reserves a country has?

Does most of the worlds gold just sit in vaults and not move anywhere, even though it may be traded hundreds of times. What if these vaults ,where the gold is stored, were actually empty. Does anybody check them?


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## Chris (11 Aug 2009)

losttheplot said:


> Is a currency based on the amount of gold reserves a country has?


Absolutely NOT!!! All the world currencies are fiat currencies, meaning they are backed by absolutely nothing, in effect they are 'I owe you nothings'. If a currency fails, owners of the currency get nothing for it.




losttheplot said:


> Does most of the worlds gold just sit in vaults and not move anywhere, even though it may be traded hundreds of times. What if these vaults ,where the gold is stored, were actually empty. Does anybody check them?



Most of investment gold sits in vaults, and doesn't have to be moved to be traded, but often is. The Perth Mint is regularly audited, as private investors have deposits there. On the other hand, Fort Knox has not been audited since the 50s, so no one actually knows how much gold the USA have.


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## Chris (13 Aug 2009)

If you're really interested read Ludwig von Mises - The Theory of Money and Credit

You can download a free pdf at the Ludwig von Mises Institute website:
http://mises.org/literature.aspx


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## Purple (14 Aug 2009)

Money is an exchangeable measure of the wealth of a nation or collective group of nations that hold a common currency. It makes little difference if that “money” is gold, coin or paper since none of them have any real intrinsic value. 
The motion that precious metal has any intrinsic value was shown to be false when the Spanish mined hundreds of tonnes of silver out of a mountain side in Peru, massively increasing the supply of silver. The net result was a huge drop in the value of silver in general, and their currency in particular, and the beginning of the end of the Spanish Empire.


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## packard (14 Aug 2009)

It's a bit of crappy paper with silly drawings on the front and the bigger the piece of paper the more you have, a bloody awful thing that consumes us all.


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## camlin90 (15 Aug 2009)

Protocol said:


> Indeed, I have been thinking recently that we should move to a cashless economy. (Note: there would still be money, but no cash)



http://business.timesonline.co.uk/tol/business/economics/article6531299.ece

No thanks.


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## milic (15 Aug 2009)

What is money?

Easy one, this. It's the root of all evil.


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## Purple (15 Aug 2009)

milic said:


> What is money?
> 
> Easy one, this. It's the root of all evil.



Nope, the quote is "Love of money is the root of all evil".


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## joe sod (15 Aug 2009)

"The database stores the entries as tiny magnetic patterns on ferrous disks. Copies of this pattern are made regularly and saved on magnetic tape. When the clerk wants to look at a customer's balance, a copy of the pattern on disk is transposed to a different pattern of charged capacitors in a computer's volatile memory. The computer communicates this pattern of charges to make a human readable display on the clerk's terminal.

This isn't really money, though is it? "

I have thought about this alot too, it asks the question can banks simply create money out of nothing since as you say alot of money exists as bites on banks computer systems not as notes and coins, to an extent they can, however banks are monitored by the central bank and in our case indirectly by the european central bank, therefore if banks attempted to do this the central bank would know about it as it would not tally with their figures for money supply, it is obvious that banks cant create money out of nothing because this is what anglo et al would be at now rather than looking to the government for bail outs. However central banks do have the power to create money out of nothing this is what the Fed is at, and this is also what mugabes zimbabwe is at, however there is also a check here because international money markets will then lower the price of the currency, therefore even central banks cannot create money without some cost


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## Purple (15 Aug 2009)

joe sod said:


> I have thought about this alot too, it asks the question can banks simply create money out of nothing since as you say alot of money exists as bites on banks computer systems not as notes and coins, to an extent they can, however banks are monitored by the central bank and in our case indirectly by the european central bank, therefore if banks attempted to do this the central bank would know about it as it would not tally with their figures for money supply, it is obvious that banks cant create money out of nothing because this is what anglo et al would be at now rather than looking to the government for bail outs. However central banks do have the power to create money out of nothing this is what the Fed is at, and this is also what mugabes zimbabwe is at, however there is also a check here because international money markets will then lower the price of the currency, therefore even central banks cannot create money without some cost




If there was one hundred US dollars in circulation each would be worth one one-hundredth of the total wealth of the USA.
If there was one trillion US dollars in circulation each one would be worth one one-trillionth of the total wealth of the USA.
etc.

It’s not quite that simple but it illustrates what money is.
Printing more money simply changes the fractional value of each currency unit. It takes time for this to happen but it always does.


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## Duke of Marmalade (16 Aug 2009)

Purple said:


> ...It’s not quite that simple but it illustrates what money is.


It certainly ain't that simple. The basic accounting identity is as follows: 

[P]rice level = [M]oney supply x [V]elocity of circulation / [Q]uantity

Your formula is P = M / Q.

In the first place you are using the wrong Q. It is not the standing wealth of an economy that measures Q but its production of goods and services. It is possible to conceive of an economy with not much standing wealth but significant economic activity.

But in ignoring the velocity of circulation (propensity to spend money) that is oversimplifying. 

The primary economic objective is to maximise Q, a secondary objective is to stabilise P. M is the lubricant of the economy. It is possible to increase the supply of this lubricant without increasing the price level if, for example, the economy is operating below full capacity or if people are hoarding the money i.e. reducing the velocity of circulation. In the current recession both these factors are present and it is therefore arguably correct to increase the money supply, call it printing if you like.


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## Purple (16 Aug 2009)

Duke of Marmalade said:


> It certainly ain't that simple. The basic accounting identity is as follows:
> 
> [P]rice level = [M]oney supply x [V]elocity of circulation / [Q]uantity
> 
> ...



Yes, I did leaving cert economics as well.
Increasing money supply when the velocity of supply is reduced is fine but as the velocity increases and the economy approaches full capacity the supply will have to be adjusted again as  _"Printing more money simply changes the fractional value of each currency unit. It takes time for this to happen but it always does."_


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## Duke of Marmalade (16 Aug 2009)

Purple said:


> Yes, I did leaving cert economics as well.


_Purple_, I was not any way doubting your understanding. But in the words of Einstein everything should be as simple as possible but no simpler than that. I just thought you were oversimplifying a tad, that's all.


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## Marc (20 Aug 2009)

[FONT=&quot]“There can be no doubt that besides the regular types of the circulating medium, such as coin, notes and bank deposits, which are generally recognised to be money or currency, and the quantity of which is regulated by some central authority or can at least be imagined to be so regulated, there exist still other forms of media of exchange which occasionally or permanently do the service of money.[/FONT]
  [FONT=&quot] [/FONT]
  [FONT=&quot]Now while for certain practical purposes we are accustomed to distinguish these forms of media of exchange from money proper as being mere substitutes for money, it is clear that, other things equal, any increase or decrease of these money substitutes will have exactly the same effects as an increase or decrease of the quantity of money proper, and should therefore, for the purposes of theoretical analysis, be counted as money.”[/FONT]
  [FONT=&quot] [/FONT]
  [FONT=&quot]Friedrich Hayek, [/FONT]_[FONT=&quot]Prices and Production [/FONT]_[FONT=&quot]1931 - 1935.[/FONT][FONT=&quot][/FONT]


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