What Is Money?

[Home]

We all handle money every day. On the surface, it seems pretty simple. It's not as simple as you might like, but it's simpler than you're probably thinking by now. There's some subtleties that, once understood (and perhaps experimented with), can lead to a real mastery of money. Over the next few articles we'll go over what money is, the principles under which it operates, some more complex systems we've built on top of it, and finally we'll look at some of the wisdom surrounding money from different cultures and eras throughout the world.

Click for more details.

All money has the following functions:

  • It may be used as a unit of account.
  • It may be used as a store of value.
  • It may be used as a medium of exchange.
Money comes in many forms, each with their own special twists on the idea. To function as money, they must all have these abilities in common; no kind of true money can exist in which any one of these three functionalities is absent.

Essentially, this means that with any real money you can budget & bookkeep; invest and—all other things being equal and static—have a reasonable expectation of maintaining your cash value; and purchase goods, assets, and services (GAS).

Money also needs to have some other properties. It must be fungible, meaning it's interchangeable and you can exchange one denomination for an equal value in another denomination; that is, for example, you can exchange a $20 bill for two $10 bills, or four $5 bills, or even a $10 bill, a $5 bill, and five $1 bills, and so on.

A unit of account is a way of measuring the lingering & flowing of money; that is, it is the unit in which value in a given system is expressed. Let's make an example:

  • You want to save for a modest house, costing $100,000.
  • You earn $50,000 per year, from your salary.
  • For the sake of the argument, you spend precisely half of your salary on living expenses.
  • You split the surplus 50/50, between prudence and pleasure; meaning half gets saved, and the other half is used for fun.
Given the above scenario, your savings comes out to $12,500 per year. This figure represents 1/8 of the cost of the house you'd like. You could also express this value in the (imaginary) unit of account, houses; in such a case, this same value could be expressed as 0.125 houses per year, and your salary would become 0.5 houses per year.

Another way of thinking about units of account is that they're a way to assign numbers to different values in a financial system—even if those values are tied to entirely different assets, and potentially noted in still other units of account, so long as the conversion rate is known—and thereby ease tracking of changes in the system. A fund manager might measure the value of his portfolios in dollars—even if they were actually bought with other currencies.

A store of value is something that can be stored for long periods and retrieved later, and can be expected to maintain value over that time, but never at the expense of losing purchasing power over time, if you can avoid it. This process is called investing, by the way; this contrasts to speculation, which is often mistaken for investing by newcomers, and errantly labeled the same by speculators—as well as some financial advisors, for whom the offense should carry some kind of (minor) penalty, it should be considered that terrible a misguidance—much to the chagrin of investors the world over.

Crucially, it needs to be fungible and arbitrarily exchangeable. In other words, at any time it needs to be easy to convert into some form of usable value in some way, either through direct use or through a timely and easy conversion to an asset that is directly useable.

Gold has traditionally been held as a great store of value, and it's easy to see why; it's because gold is:

  • Malleable, making it easy to form into coins, for example.
  • Stable, being unaffected by mostly anything it'd come into contact with on a daily basis.
  • Fungible, unless made into fine crafts such as jewelry.
  • Always in demand; For most of history it was universally in high demand, meaning it was easy to exchange gold for GAS. Even today many countries still base the value of their money on it, and a good few countries have private market sectors for it.
Given these facts, we now have a standard by which to compare other stores of value further down the road.

A medium of exchange is simply anything that is used as money; it is not necessarily money, but could instead be any commodity agreed upon in a community as having value. Some examples would be reward/loyalty points at a store chain, or cigarettes & other drugs in prison.

This is what gives money its ability to be used to buy GAS. Without it, society would have to resort to barter, or other much less efficient systems of economy.

Value is the purchasing power underlying money. It is measured in the unit of account. This determines how much a given amount of money is worth. Going back to our earlier example with the house; if you owned the house and the surrounding land, you could (in theory) make shares of it and give them to the residents and local businesses as payment, if they'll take them.

The shares would be like money, acting as a medium of exchange, a unit of account and a store of value; for a single share, that value would be one share's worth of the estate's value, for example measured in dollars. You would be able to walk into a store, buy say, $20 of stuff, and pay for it with your shares of the estate. The store could optionally price items in shares rather than dollars. Throughout history, there are places where this has been done!

These shares would make poor money in a larger community such as a large nation, however; unless this sort of system were widely adopted with agreed upon common pricing, for most it would be difficult to exchange for other forms of purchasing power, judge how much their money was actually worth, or invest it with reasonable expectations of returns. In addition, since the money would grant the holder part ownership of a parcel of land, the further you were from that land the less likely it would be that anyone would take it.

All good forms of money obey these simple rules, and can be used to enrich one's life if handled correctly. Mastery of money requires first understanding the medium of the craft; over the next few posts we'll continue our first journey through finance.

I hope you've enjoyed this article. If you did, please consider subscribing via RSS so you can be notified of future posts. If you're a Brave user, please consider sending me a tip or adding me to your monthly contributions.