What is money? (Part II)

January 30th, 2012

Photo: BreakTheMatrix.com

Last week, we explored the three functions that money serves and learned that money has enabled so many of the modern world’s advances in material prosperity and standards of living by acting as a: 1) Medium of exchange, 2) Unit of account, and 3) Store of value. If you haven’t already read it, please read What is money? (Part I) to familiarize yourself with these roles that money plays and why they are so essential to the material success we all enjoy today.

If you’ve read Part I, you’re ready for Part II below, where we’ll explore what characteristics money has to have in order to fulfill these roles…

In order to serve as a medium of exchange, a unit of account, and a store of value, money must have certain characteristics, or it will not work. It must be:

1. Scarce – Money must be relatively scarce in order to function as a medium of exchange, a unit of account, and a store of value. It would be impractical to use something like soil or sand as money because it is not scarce enough. It is so easily accessible to anyone that you would need vast amounts of it to exchange for other products, making it a poor medium exchange. To exchange the surplus of one’s labor for sand and store that surplus value as sand would also take an impractical amount of time and resources to measure out and store the sand. This illustrates why money must be scarce in order to function practically.

2. Portable – Money must also be portable. If it’s going to be used as a medium of exchange, it must be something that can easily be transported to a marketplace and even across great distances, especially in an increasingly global marketplace. A rare tree might be scarce, but transporting trees is cumbersome, expensive, and impractical. Rare trees would not make a good money supply because they are not easily portable. Could you imagine hauling a tree to an auto dealership to buy a car?

3. Marketable – Money must be widely marketable. It must be something that there is a broad demand for. The more universal the demand, the better the commodity is as a candidate for use as money. There’s simply not a broad enough demand for acoustic guitars for instance, to use them as money. The number of people who have an interest in them and derive value from them is too small. Money must be something that is broadly in demand, and most likely something that has commercial applications and value.

4. Durable – Money must be durable. In Part I, we used the example of a fisher as someone who might want to store anything he or she catches in excess of what’s necessary to survive by exchanging it for money. Money therefore, has to be something durable. Fish would make poor money because they would rot, and are therefore unsuitable to act as a store of value. As often as money changes hands, it also must be durable in order to act as a medium of exchange. If it is to accurately assess the amount of value a producer has created by functioning as a unit of account, money must also be durable.

5. Fungible – To be fungible means that any given unit of the money supply is identically valuable to any other given unit. This is important if money is to be a medium of exchange. For instance, few people have the expertise, and no one practically has enough time to inspect the quality of a precious gem like a diamond to ascertain its value before exchanging something for it. No diamond is like any other, and no two have the same value. Using them as a medium of exchange or a unit of account would be chaotic and unmanageable. Fungibility also allows the money supply to be made into smaller and smaller units for ease of portability and for precise measurements of value.

Conclusion: In order for money to serve its three roles as a medium of exchange, unit of account, and store of value, it must have certain qualities. Money must be scarce, portable, marketable, durable, and fungible. If it is missing any of these five qualities, a commodity will not be able to serve optimally as a supply of money. If it is missing multiple qualities, it will serve poorly as a supply of money. There are different instances throughout history of less-than-optimal commodities being used in certain markets or special circumstances as money, but history has also shown that human beings typically prefer just a few commodities for use as money because they have all five qualities of a sound money supply. In What is money Part III, we will examine what the world uses for money today and what logically would serve best as money according to the criteria outlined in Parts I and II.


About the Author: Wes
