UPFINA's Mission: The pursuit of truth in finance and economics to form an unbiased view of current events in order to understand human action, its causes and effects. Read about our mission here.
What is money? Are you confusing currency with money or vice versa? Not understanding the difference between the two can, unfortunately, force you into making unwise long-term investment decisions with your life’s savings.
Why do we need money? You can exchange your time creating goods/services for goods or services, otherwise known as barter. However, a barter system is not the most efficient exchange of value. For example, if you work at a factory manufacturing windows, and the only form of compensation that the plant can provide you for your time is in the form of windows, would that be valuable to you? What if the value of one window is equivalent to ten hours of your labor and you work for only five hours, does the manufacturer cut the window in half and compensate you? However, due to breaking the window in half, the value of the window changes by more than 50%, because the usefulness of a broken window (or half a window) is closer to zero hours of your time than to five.
While this is a simplistic model, it demonstrates effectively the inefficiencies created as a consequence of a reliance on barter. Additionally, how do you use a window, or the knowledge of constructing a window, to effectively and efficiently compensate the grocery store owner when you purchase food on a weekly basis? Therefore, we return to our question of what provides us with the most economical, efficient and effective means of transporting value in society. The answer is either currency or money. Keep in mind; there is a distinct and significant difference between what is currency and what is money.
What Is Money?
Money is an asset, a tool, that allows you to transport value through time in exchange for goods and services. Money cannot be the answer for the greed, fear, nor hate of a host, the person. Just like a shovel is only a tool, it can be used for both good as well as evil.
- Currency – a unit of account that is durable, portable, divisible, and interchangeable which serves as a medium of exchange.
- Commodity – a raw material in finite supply that is in demand for consumption or production.
- Money – a currency that is a commodity.
The value of currency and money is determined as follows:
- Industrial Value = Supply and demand for asset/commodity
- Investment Value = Supply and demand by investors
- Value of Currency = Investment Value
- Value of Money = Industrial Value + Investment Value
For anything to qualify as money, it must have a tangible use outside the realm of being a currency (medium of exchange). Money is the currency that, also, is utilized in the production of goods and services. For example, if you have a copper coin, you can melt it and use it in the creation of a copper wire for the electricity in your home, vice versa. The Federal Reserve Note (FRN) (United States Dollar, USD) is a currency and is not money because it has no tangible use as a commodity. Thus, it relies entirely on its investment value.
Here is an explanation from the US Treasury:
Federal Reserve notes are not redeemable in gold, silver or any other commodity, and receive no backing by anything This has been the case since 1933. The notes have no value for themselves, but for what they will buy. In another sense, because they are legal tender, Federal Reserve notes are “backed” by all the goods and services in the economy.
The Value Of Money
Could a banana be money? Technically, if there was no better alternative, such as on a deserted island, a banana could be considered as money even though it decays rapidly and will only serve useful for at most a week, depending on how it is stored. Still, if you see the abundance of the Earth’s resources (commodities) today, a banana could not be an acceptable form of money due to its numerous flaws – including being of different weights, varieties, ripeness, and so on.
The preference to hold money instead of a currency presupposes that you are making a conscious decision that the commodity will serve valuable in industrial purposes longer than any possible investment manias that may affect the investment value of either currencies or money. As such, this industrial value provides the money with “intrinsic value”, higher than zero. Whereas, because currencies do not have a constant non-monetary purpose, they are prone to the booms and busts of investment manias as well as the mismanagement by the creator such that the intrinsic value of currencies can reach zero.
The key to successful money is that no single party controls it. You cannot easily create it to dilute the value of the existing supply of money. Therefore, before you examine any investment opportunities or simply stow away that hard earned currency for retirement – ask yourself – will the currency itself retain its purchasing power five, ten, or thirty years into the future? Do you trust the current manager and creator of the currency to be your fiduciary and look out for your best interests while preserving the value of the currency? The best answer to understanding how to transfer value and purchasing power from today into the future can perhaps be understood better by examining the past. While the past is not prologue, understanding the lessons of history is paramount to being prepared for the future.
Have comments? Join the conversation with us on Twitter.