(MONEY)

                                   MONEY.
   MONEY IS USED FOR BUYING OR SELLING GOODS, FOR MEASURING  VALUE  AND  FOR
STORING WEALTH. Almost every society now has a money economy based on coins
and paper notes of one kind or another. However, this has not  always  been
true. In primitive societies a system of barter  was  used.  Barter  was  a
system of direct exchange of goods. Somebody could exchange  a  sheep,  for
example, for anything in the market place that they considered to be  equal
value. Barter however was a very  unsatisfactory  system  because  peoples
precise needs seldom coincided. People needed a more  practical  system  of
exchange, and various money systems developed based  on  goods,  which  the
members of a society recognized as having a value.  Cattle,  grain,  teeth,
shells, features, skulls, salt, elephant tusks and tobacco  have  all  been
used. Precious metals gradually took over because, when  made  into  coins,
they were portable, durable, recognizable, and divisible  into  larger  and
smaller units of value.
      A  coin  is  a  piece  of  metal,  usually  disc-shaped,  which  bears
lettering, designs or numbers showing its value. Until the  18th  and  19th
centuries coins were given monetary worth based  on  the  exact  amount  of
metal contained in them, but most modern coins are based on face value, the
value the governments choose to give them, irrespective of the actual metal
content. Coins have been made of  gold  (Au),  silver  (Ag),  copper  (Cu),
aluminum (Al), nickel (Ni), lead (Pb), zinc (Zn), plastic and in China even
from pressed tealeaves.  Most governments now issue paper money in the form
of notes, which are promises to pay". Paper money is obviously  easier  to
handle and much more convenient in the modern world. Checks, bankers, cards
and credit cards are being used increasingly and it is possibly to  imagine
a world where money in the form of coins  and  paper  currently  will  no
longer be used. Even today,  in  the  U.S  many  places-especially  filling
stations-will  not   accept   cash   at   night   for   security   reasons.

.

                 Barter and the Double Coincidence of Wants
As long as specialization was  limited,  desirable  trades  were  relatively
easy to uncover. As the economy developed, however,  greater  specialization
in the division of labor increased the  difficulty  of  finding  goods  that
each trader wanted to exchange. Rather  than  just  two  possible  types  of
producers, there were, say, a  hundred  types  of  producers,  ranging  from
potters to shoemakers. The potter in need of new shoes  might  have  trouble
finding a shoemaker in need of pots. Barter depends on a double  coincidence
of wants, which occurs only when  traders  are  willing  to  exchange  their
product for what the other is  selling.  The  cobbler  must  be  willing  to
exchange shoes for the pots offered by the potter, and the  potter  must  be
willing to exchange pots for the shoes offered  by  the  cobbler.  Not  only
might this double coincidence of wants be hard to find  but  after  the  two
traders connect they would also need to agree upon a rate  of  exchangethat
is, how many pots should  be  exchanged  for  a  pair  of  shoes?  Increased
specialization made the barter system of exchange  more  time-consuming  and
cumbersome.
  When only two  goods  are  produced,  only  one  exchange  rate  must  be
determined, but as the number of goods produced in  the  economy  increases,
the number of exchange rates grows sharply. Negotiating the  exchange  rates
among commodities is complicated in a barter economy  because  there  is  no
common measure of value. Sometimes the  differences  in  the  value  of  the
products made barter difficult. For example, suppose the cobbler  wanted  to
buy a home. If a home exchanged for 2000 pairs of shoes, the  cobbler  would
be hard-pressed to find a home seller in need  of  that  many  shoes.  These
difficulties with barter have led even very simple and  primitive  economies
to use money, as we will see next.

                      Earliest Money and Its Functions
We have  already  discussed  the  movement  from  self-sufficiency  to  more
specialized production requiring barter. We saw that the greater the  degree
of specialization in the economy, the more difficult it became  to  discover
a double coincidence of wants and  then  to  negotiate  mutually  beneficial
exchanges. We should note that nobody actually  recorded  the  emergence  of
money. Thus, we can only speculate about how money first came into use.

Through repeated exchanges, traders may have found that there  were  certain
goods for which there was always a ready market. If a trader could not  find
a desired match or did not need goods for immediate consumption,  some  good
with a ready market could be accepted instead. So traders  began  to  accept
certain goods not for immediate consumption but because  these  goods  would
be acceptable to others and therefore could be retraded later. For  example,
corn might become accepted because traders knew corn was always  in  demand.
As one good became generally acceptable in return for all other goods,  that
good began to function as money. As we will see, anything that  is  used  as
money serves three important functions: a medium of exchange, a standard  of
value, and a store of wealth.

Medium of Exchange   If a community, by luck or  by  design,  can  find  one
commodity that everyone accepts in exchange for whatever  is  sold,  traders
can save much time, disappointment, and sheer  aggravation.  Separating  the
sale of one good from the purchase of another requires something  acceptable
to all parties involved in the transaction. Suppose corn plays this role,  a
role that clearly goes beyond its usual function as food.  We  call  corn  a
medium of exchange because corn is accepted in exchange by  all  buyers  and
sellers, whether or not they want  corn  for  its  own  uses.  A  medium  of
exchange is anything that is generally accepted  in  return  for  goods  and
services sold. Corn is no longer an end but a means to an end. The  end  may
be shoes, meat, pots, whatever. The person who accepts corn in exchange  for
some product may already have more corn than the entire family could eat  in
a year, but the corn is not accepted with a view toward consumption.  It  is
accepted because it can be readily exchanged for other goods.  Corn  can  be
used to purchase whatever is desired whenever  it  is  desired.  Because  in
this example corn both is a commodity and serves as money, we  call  corn  a
commodity money. The earliest money was commodity money.

Standard of Value   As one commodity, such as corn, became widely  accepted,
the prices of all goods came to be quoted  in  terms  of  corn.  The  chosen
commodity became a common standard of value. The  price  of  shoes  or  pots
could be expressed in bushels of corn. Thus, not only does corn serve  as  a
medium of exchange but it also becomes a yardstick for measuring  the  value
of all goods and services. Rather than having to quote the rate of  exchange
for each good in terms of every other good, as was the case  in  the  barter
economy, the price of everything could be measured in  terms  of  corn.  For
example, if a pair of shoes sells for two bushels of corn and a  five-gallon
pot sells for one bushel of corn, then one pair of shoes exchanges  for  two
five-gallon pots.

Store of Wealth   Because people often do not want to make purchases at  the
same time they sell an item, the purchasing  power  acquired  through  sales
must somehow be preserved. Money serves as a store of  wealth  by  retaining
purchasing power over time. The cobbler exchanges  shoes  for  corn  in  the
belief that other suppliers will accept corn in exchange  for  whatever  the
cobbler demands later. Corn represents a way of deferring  purchasing  power
yet conserving that power until consumption is desired. The better money  is
at preserving purchasing power, the better it serves as a store of wealth.
   When we think of someone selling one good in order to be able  to  buy  a
second good, then the exchange of the first good for corn is only  half  of
the exchange. Goods are first exchanged for the commodity money, corn; corn
is -later exchanged for other goods. Breaking the exchange in two  is  much
more convenient than trying to work out  a  barter  arrangement,  with  its
frequent delays and disappointments. With money,  the  buyers  and  sellers
need to have only one good in common instead of two.
   Any commodity that acquires a high degree of acceptability throughout the
economy thereby becomes money. Consider some commodities used as money over
the centuries. Cattle served as money, first for the Greeks  and  then  for
the Romans. In fact, the word pecuniary comes from the  Latin  word  pecus,
meaning "cattle." Other commodity moneys  used  at  various  times  include
tobacco and wampum (polished strings of shells) in  colonial  America,  tea
pressed into small cakes in Russia, and dates in North Africa.

Whatever serves as a medium of exchange is called money, no matter  what  it
is, no matter how it first came to serve as a medium  of  exchange,  and  no
matter why it continues  to  serve  this  function.  So  long  as  there  is
something that sellers  willingly  accept  in  exchange  for  whatever  they
sellrather than looking around for goods they in particular would  like  to
consumethat article is money, whether it is animal, vegetable, or  mineral.
The only test for money is that it be widely accepted in  return  for  goods
and services. Some kinds of money perform this function well, others not  so
well.     But     good     or      bad,      it      is      all      money.


                        Problems with Commodity Money
Corn does as well as some  other  commodities  that  have  served  as  money
throughout history. But there  are  problems  with  most  commodity  moneys,
including corn. First, corn must be properly  stored  or  its  quality  will
deteriorate; even then, it will not maintain its quality for  long.  Second,
corn is bulky,  so  exchange  becomes  unwieldy  for  major  purchases.  For
example, suppose a new home cost 50,000 bushels of corn. Many truckloads  of
corn would be involved in such a transaction. Third, if all corn  is  valued
equally in exchange, people will tend to keep the best corn and  trade  away
the lowest-quality corn. The quality of corn in circulation  will  therefore
decline, reducing the acceptability of  this  commodity  money.  Sir  Thomas
Gresham, founder of the Royal Exchange of London, pointed out  back  in  the
sixteenth century that "bad money drives out good money," and this has  come
to be known as Gresham's Law". When moneys of  different  quality  circulate
side .by side, people tend to trade away the inferior money  and  hoard  the
best.
      A final problem with corn as with other commodity moneys is  that  the
value  of  corn  depends  on  its  supply  and  demand,  which   may   vary
unpredictably. On the supply side, if a bumper crop increases the supply of
corn, corn would likely become less valuable, so more corn  would  exchange
for all other goods. On the demand side, any change in the demand for  corn
as food would alter the amount available as a medium of exchange, and this,
too, would influence the value of corn. Erratic fluctuations in  the  value
of corn limit its usefulness as money, particularly as a store  of  wealth.
If people cannot rely on  the  value  of  corn  over  time,  they  will  be
reluctant to hold it as a store of wealth. More generally, since the  value
of money depends on its supply being limited, anything that can  be  easily
produced by anyone would not serve well as commodity  money.  For  example,
dirt would not serve well as commodity money.

                         Metallic Money and Coinage
Throughout history several metals were used as commodity  moneys,  including
iron and copper. More important, however, were the precious  metals  silver
and goldwhich have always  been  held  in  high  regard.  The  division  of
commodity money into units was often quite natural, as in a bushel  of  corn
or a head of cattle. When rock salt was used  as  money,  it  was  cut  into
uniform bricks. Since salt \vas usually  of  consistent  quality,  a  trader
needed only to count the bricks to  determine  the  amount  of  money.  With
precious metals, however, both the  quantity  and  quality  became  open  to
question. Because precious metals could be debased with cheaper alloys,  the
quantity and quality of the metal had to be ascertained with each exchange.
   This quality-control problem was  addressed  by  coinage.  Coinage,  when
fully developed, determined both the amount of metal and the quality of the
metal. The use of coins allowed payment by count  rather  than  by  weight.
Initially, coins were stamped only on one side, but undetectable amounts of
the metal could be "shaved" from the smooth side of the  coin.  To  prevent
shaving, coins were stamped on  both  sides.  But  another  problem  arose.
Because the borders of coins remained blank, small  amounts  of  the  metal
could be "clipped" from the edges. To prevent  this,  coins  were  bordered
with a well-defined rim and were milled around the edges.  If  you  have  a
dime or quarter, notice the tiny serrations on  the  edge  plus  the  words
along the border. These features, throwbacks from the time when these coins
were silver rather  than  a  cheap  alloy,  prevented  the  recipient  from
"getting clipped."
   The power to coin  money  was  viewed  as  an  act  of  sovereignty,  and
counterfeiting, an act  of  treason.  In  England  the  king  extended  his
sovereignty only to silver and gold coins. When the face value of the  coin
exceeds the cost of coinage, the minting  of  coins  becomes  a  source  of
revenue to the sovereign. Seigniorage refers  to  the  amount  of  precious
metal  extracted  by  the  sovereign,  or  the  seignior,  during  coinage.
Debasement of the currency represented a source of  profit  for  profligate
governments. Token money is the  name  given  to  coins  whose  face  value
exceeds their metallic value.

                              Money and Banking
      Early banks were little more than moneychangers, exchanging coins  and
bullion (uncoined gold or silver bars) from one form to another for  a  fee.
Money was counted on a banque, the French word for "bench." Banking, as  the
term  is  understood  today,  dates  back  to  London  goldsmiths   of   the
seventeenth century. Because goldsmiths had a safe in which to  store  gold,
others in the community came to rely on goldsmiths to hold their  money  and
other valuables for safekeeping. The goldsmith found  that  when  money  was
held for many customers, deposits and withdrawals tended to balance out,  so
a pool of deposits remained in the safe at a fairly  constant  level.  Loans
could be made from this pool of idle cash,  and  the  goldsmith  could  thus
earn interest.
      The system of keeping one's money on deposit with  the  goldsmith  was
safer than leaving money where it could be easily stolen, but it was  a  bit
of a nuisance to have to visit the goldsmith each  time  money  was  needed.
For example, the farmer would visit the goldsmith to withdraw  enough  money
to buy a horse. The farmer  then  paid  the  horse  trader,  which  promptly
deposited the receipts with the goldsmith. Thus, money  took  a  round  trip
from goldsmith to farmer to horse trader  and  back  to  goldsmith.  Because
depositors grew tired of going to the goldsmith every time  they  needed  to
make a purchase, the practice developed whereby a  purchaser,  such  as  the
farmer, wrote the goldsmith instructions to pay the  horse  trader  so  much
from the farmer's account. The payment  amounted  to  having  the  goldsmith
move gold from one stack (the farmer's) to  another  (the  horse  trader's).
These written instructions to the goldsmith were the first checks.
      By combining the idea of cash loans w4th checking, the goldsmith  soon
discovered how to make loans by check. The check was a  claim  against  the
goldsmith, but  the  borrower's  promise  to  repay  the  loan  became  the
goldsmith's asset. The goldsmith could extend a loan by creating an account
against which the borrower could write checks.  Goldsmiths,  or  banks,  in
this way were  able  to  "create  moneysthat  is,  create  claims  against
themselves that were -generally accepted as a means of paymentas a  medium
of exchange. This money, though based only on an entry in  the  goldsmith's
ledger, was accepted because of the public's confidence that  these  claims
would be honored. The total claims against the bank consisted  of  customer
deposits plus deposits created through loans. Because these claims  against
the bank exceeded the bank's gold and other reserves, this  was  the  first
fractional reserve banking system, a system in which  only  a  portion,  or
fraction, of deposits  were  backed  up  by  reserves.  The  reserve  ratio
measures reserves as a proportion of total deposits. For  example,  if  the
goldsmith had reserves of $5000 but total deposits of $10,000, the  reserve
ratio would be 50 percent.

                                 Paper Money
Another way a bank could create claims against  itself  was  to  issue  bank
notes. In London, goldsmith bankers introduced bank notes about the same  as
they introduced checks. Bank notes were pieces of  paper  that  promised  to
pay the bearer a specific amount in gold when presented to the issuing  bank
for redemption.  Whereas  only  the  individual  to  whom  the  deposit  was
directed could redeem checks, notes could be redeemed  by  anyone  who  held
them. Notes redeemable for gold or another  valuable  commodity  are  called
fiduciary money. Fiduciary money was often  "as  good  as  gold"  since  the
bearer could,  upon  request,  redeem  the  note  for  gold.  In  some  ways
fiduciary money was better than gold because it took up less space  and  was
easier to carry.
      The amount of fiduciary money issued depended on the  bank's  estimate
of the proportion of notes that would be redeemed for gold. The greater  the
redemption rate, the fewer notes could be issued based on a given amount  of
gold reserves. Initially, these promises to  pay  in  gold  were  issued  by
private individuals or banks, but over time governments developed  a  larger
role in their printing and circulation. The tendency  to  redeem  notes  for
gold depended on the note holder's confidence in the bank's  willingness  to
do so upon request.
      Once fiduciary money became widely accepted, it was perhaps inevitable
that governments would begin issuing fiat money,  which  consists  of  notes
that derive their status as money by power  of  the  state,  of  fiat.  Fiat
money is money because the government says it is money. Fiat  money  is  not
redeemable for anything other than more fiat money; it is not  backed  by  a
promise to pay something of intrinsic value. You can think of fiat money  as
mere paper money. It is acceptable not because it  is  intrinsically  useful
or valuable but because the government  requires  that  it  be  accepted  as
payment. Fiat money is declared legal  tender  by  the  government,  meaning
that creditors must accept it as payment for debts. Gradually,  people  came
to accept fiat money because of the belief that others would  accept  it  as
well. The money issued in the United States today and, indeed,  paper  money
throughout most of the world is now largely fiat money.

                             The Value of Money
Why does money have value? As we have seen, various  commodities  served  as
the earliest moneys. Commodities such as corn or tobacco had  value  in  use
even if for some  reason  they  became  less  acceptable  in  exchange.  The
commodity feature of the money bolstered confidence  in  its  acceptability.
When paper money came into use, acceptability was initially fostered by  the
promise to redeem it  for  gold  or  silver.  But  since  most  paper  money
throughout the world is now fiat money, there is no promise of redemption.
So why can a piece of paper bearing the image of Alexander  Hamilton  and  a
10 in each corner be exchanged for a large pepperoni pizza or anything  else
selling for $10. People accept these pieces of paper  because  they  believe
others will do so. Fiat money has no value other  than  its  ability  to  be
exchanged for goods and services now and in the future. Its  value  lies  in
people's belief in its value.
      The value of money is reflected by its purchasing  powerthe  rate  at
which money is exchanged for goods and services. The higher the price level
is, the fewer goods and services can be purchased with each dollar, so  the
less each dollar is worth. The purchasing  power  of  each  dollar  can  be
compared over time by accounting for changes in the price level. To measure
the purchasing power of the dollar in a particular year, first compute  the
price index for that year,  then  divide  100  by  that  price  index.  For
example, the consumer price index for 1986 was 328, using 1967 as the  base
year. The value of a 1986 dollar  is  therefore  100/328,  or  about  SO.30
measured in 1967 dollars. Thus, a 1986 dollar buys less than one-third  the
goods and services purchased by a dollar in 1967.

                        Too Much and Too Little Money
Money serves as a medium of exchange, a standard of value, and  a  store  of
wealth. One way to understand  these  functions  of  money  is  to  look  at
situations in which money did not perform these functions  well.  Money  may
not function well as a medium  of  exchange  because  there  is  too  little
money, too much money, or  because  the  price  system  is  not  allowed  to
operate. With prices growing by the hour,  money  no  longer  represented  a
stable store of wealth,  so  people  were  unwilling  to  hold  money.  With
rapidly rising prices, relative prices also became distorted, so buyers  and
sellers had difficulty knowing the appropriate price  of  each  good.  Thus,
money became less useful as a  standard  of  valuethat  is,  as  a  way  of
comparing the price of one good relative to another. Money still  served  as
a medium of exchange, but as larger and larger amounts of money were  needed
to carry out the simplest purchases, money became more cumbersome.  Exchange
demanded more time and energy. In short, when there is too much  money,  the
economy becomes less productive than when there is an appropriate amount  of
money.
      On the other hand, if there is too little money in the economy  or  if
the price system is not allowed to function, the economy may be  reduced  to
barter, and, as we have seen,  barter  is  inefficient.  For  example,  just
after World War  II  money  in  Germany  became  -largely  useless  because,
despite tremendous inflationary pressure in the economy,  occupation  forces
imposed strict price controls. Since prices were set well below what  people
thought they should be, sellers stopped accepting money, forcing  people  to
use barter. Experts estimate that because of the lack of a viable medium  of
exchange, the German economy produced only half the  output  that  it  would
have produced with  a  smoothly  functioning  monetary  system.  The  German
"economic miracle" that occurred after 1948 can be credited  in  large  part
to that country's adoption of a reliable monetary system. It has  been  said
that  no  machine  increases  the  economy's  productivity   like   properly
functioning money. Indeed, it  seems  hard  to  overstate  the  value  of  a
reliable monetary system. Consider  in  the  following  case  study  a  more
contemporary example of the official currency failing to  serve  well  as  a
medium of exchange.

                                 Conclusion
  Just as the division of labor creates the  need  for  exchange,  exchange
creates the need for money. With  money,  exchange  need  not  rely  on  the
double coincidence of wants required with  barter.  People  can  sell  their
labor in return for money to be used for future consumption.
1. Barter was the first form of exchange. As the  degree  of  specialization
grew, it became more difficult to uncover the double coincidence  of  wants
required with barter. The time and inconvenience involved with  barter  led
even simple economies to introduce money.
2. Money serves three primary functions: a medium of  exchange,  a  standard
of value, and a store of wealth. The first money was commodity money, where
a good such as corn served also as money. With fiduciary money, the  second
type of money introduced what changed hands was a piece of paper that could
be redeemed for something of value, such as silver or gold. The third  type
of money introduced was fiat money, which is paper money that  can  not  be
redeemed for anything other than more paper money. Fiat money is given  its
value as money by law. Most currencies  throughout  world  today  are  fiat
money.



" (MONEY) "