What is money?

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PaulHoughton

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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?
 
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”.
 
Protocol said:
Money is the stock of assets that can be readily used to make transactions.
Click to expand...
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:
Click to expand...
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
Click to expand...
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
Click to expand...
more uses but no definition. I still don't get it.
 
 
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?
 
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)
 
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!
 
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.
 
Duke of Marmalade said:
... The banking system/government could try to give the IOUs intrinsic value by say guaranteeing the price level for gold...
Click to expand...

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.
 
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?
 
losttheplot said:
Is a currency based on the amount of gold reserves a country has?
Click to expand...
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?
Click to expand...

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.
 
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.
 
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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