What the heck is money, actually?
You don’t need to be an economist to understand money.
So I’ve decided to start writing a series about money. I want it to be a crash course in money, suitable for all experience levels — but also to provide you with a deep, thorough understanding of the nature of money and changes in our ever-evolving monetary system. These things are important, because they affect you. We live in a society which is nested inside of an economic context. Its very stability depends on the stability and effectiveness of its monetary system, and whatever system it operates within has implications for you and your wealth. And as we will come to see in this series, money is and has been changing right underneath your feet.
Something to add. I am not a political ideologue. My goal is not to provide an interpretation of things which biases you in one way or another. It seems that most money-related content on the internet is driven by a desire to propagate ideology and politically charged narratives. This upsets me, and is why I am setting out to write this series. I think people should be able to learn about what money is, how it works and what is happening to it without being tricked into a political ideology.
The purpose of this series is education, not indoctrination. Whatever your political stance, I would prefer you understood the nature, mechanisms and real-world context of money before you tried meddling with it. So let’s learn the facts of money, and then you can apply your ideology to it afterwards if you so choose.
A *tentative* list of topics I want to cover are outlined in the graphic below. I may add, subtract or merge them as we progress through the series.
Now, by ‘money’ I mean something very specific. You might mean something else by the word money, and that’s okay — but everything I say about money in this series is about money as I have defined it. To discuss things, we are forced to choose one specific definition over any other. In this article, I will explain what the definition of money I will use in this series is, and why I chose it.
With that said, let’s get started.
The Definition of Money
Money Defined as the ‘common medium of exchange’
The definition and history of money is a hotly contested issue in economics. It’s very political, and multiple schools of thought clash on it and refuse to come to a consensus. In this series, we will see that money is something that has evolved, and is still evolving. As are our interpretations of it. Trying to define money in a way that pleases everyone is for these reasons very difficult, which is why I am opting for the simplest and most universally accepted definition: money is the common medium of exchange in an economy. The common what? Medium of exchange.
First, let’s start off by defining exchange. An exchange is a situation where somebody gives something to somebody else to receive something in return. Let me repeat that: In an exchange, Someone gives something to Somebody Else, to receive something in return. It’s really simple, and we’ve all done it. This ‘something’ could be a good (like food), a service (like cleaning), or something more abstract like higher social status, or the rights to enter, hunt, or gather food in another tribe’s territory. Unlike a donation, every exchange has two sides to it, with one side giving the other something. This ‘something’ is a payment. Normally, whatever is given in an exchange is intended to benefit the other person in some way.
For an isolated individual stuck in the middle of the desert who has nobody to trade or bargain with, no payments of any kind to anybody else occur. There is no exchange, and so there is no common medium of exchange, and so there is no money. Similarly, if there was an economy where buying and selling — where exchange — was successfully and totally forbidden (this could only be done by force), there would also be no money. Only where people are free to exchange with one another can money come to exist.
Ok, that’s exchange. So what is a medium of exchange? A medium of exchange is the thing that is exchanged for something else; the thing that is used to pay somebody else in an exchange. A means of payment. For example, if as an exchange I gave you a Ferrari and you gave me a phone in return, the Ferrari was the medium of exchange which I used, and the phone was the medium of exchange which you used. Both the Ferrari and the phone were the thing, the instrument, the medium, we used to complete our respective ends of the exchange — so they were both media of exchange.
So what is a “common medium of exchange” — if that’s what we’re defining money as? A common medium of exchange is a thing that is a generally accepted medium of exchange in an economy. Something that you can successfully exchange for other things in most situations — something that most people generally accept as payment. Like the money in your bank account! Note: if you subscribe to the traditional barter theory of money and define ‘medium of exchange’ slightly differently, read this — otherwise, read on.
Our society generally uses a common medium of exchange for transactions. We don’t use milk to pay sometimes and eggs other times. We have these standardised pieces of paper and coins which we use all the time. There is a common medium of exchange that we use — a dominant and widespread medium for exchanging in our economy (some economies may have multiple). A money! People might still exchange without money every now and then — for example, buying a Ferrari with a phone— but generally, we use our government issued money. You have probably never found yourself in a situation where you offered somebody money for something and they said “sorry, we don’t accept that here”.
You will hear from many different economic schools of thought that money has to have certain properties and meet certain criteria (a medium of exchange, a unit of account, a store of value, a standard of deferred payments, portable, durable, divisible, fungible, scarce , accepted— and the list goes on).
These complex definitions are often constructed to suit and support the theories of specific schools of thought (which often have their own political motives) — or to not risk displeasing any one of them. Or, because people want to incorporate all of the things money can do or be into the definition of money itself.
In reality, when defining money the only necessary quality (the only quality something needs to be money) is that it is a common medium of exchange. Why? Because it is the only characteristic that if money lacked, nobody would call it money anymore. It is the core concept of money. Calling something that is not a common medium of exchange money would simply be redefining money to be something other than what everyone knows it to be, and would be of much less value than just creating a new word. It would simply constitute a reconceptualisation of money, and leave us without a word for one of the most important things in all economics.
Typically, why definitions of money get complicated is that monetary properties (qualities which make something a better medium of exchange) and monetary functions (functions that the dominant medium of exchange serves in an economy) are often included in the definition of money itself. This happens because so many instances of money in history have these qualities and properties that people confuse them for essential parts of money. Although there are many qualities that may make something a better form of money, and there are qualities which money often has, no quality other than being the medium of exchange needs to be essential in the definition of money; including any others would be superfluous and reduce the descriptive power of the definition. If one still takes issue with this definition of money (“the common medium of exchange in an economy”) and wishes to assign some properties other than ‘common medium of exchange’ to the concept of money, then we can tighten the definition further and call the money I have defined “money of exchange” — and proceed accordingly.
Money of exchange (which I will just call money) is the subject of this series. This is the money that everybody cares about, wants more of and which is the focal point of many economic situations in the modern world. There is a LOT to learn just by focusing on money defined in this way, so there’s no need to let semantics stop us here.
‘Commodity money’ and ‘Pure money’
It is worth mentioning that money can be an actual thing (a good) which is valued in itself that is also used as a general medium of exchange (‘commodity money’), or ‘pure money’ (my term) completely abstracted away from any use value in itself, like the paper or digital money you might be used to. For example, many instances of money in history have been things which were already desirable in themselves (such as gold, shells, tobacco, jewellery, cigarettes) that became common media of exchange — but the money we use in today’s society has no real use value OTHER than as a medium of exchange. Its use value IS its exchange value. Meaning: you only want it because it can buy you things. Otherwise it’s just a piece of paper or pixels, valued by virtually nobody. I call money like this, which is not a commodity and not used or valued for anything other than being a general medium of exchange — ‘pure money’. This is not a formal term used in economics — I just made it up so that I can easily refer to moneys which don’t have value independent of them being money (like U.S. dollars). The money we use today is an example of ‘pure money’ — and this isn’t the first time in history we’ve had it, either.
A quick side note: Commodity money, which is demanded and valued independent of it being a medium of exchange, has more resilience against a confidence crisis than ‘pure money’. Since the value of pure money comes solely from its widespread adoption as the common medium of exchange, this means if people stopped using it for whatever reason — its value could go to zero. This doesn’t happen with a commodity money like, for example, gold, because gold would still have some value to people even if people lost faith in it as money (because of its other uses say in electronics or jewellery).
Although it wouldn’t go to zero in a confidence crisis, gold’s market value without its monetary premium (value from being money) would only end up being a very small percentage of its value as a monetary asset — so people would still find themselves significantly hurt from the confidence crisis. Even today, when gold isn’t used as money, it has a significant monetary premium (some estimate up to 80% of its total market capitalisation). This means, if a commodity like gold was the dominant medium of exchange and people lost faith in it as money, one would still lose a lot (but not all) of their wealth in the process of its de-monetisation. One might still argue that commodity money is less likely to suffer a confidence crisis than pure money — but this claim would require substantiation and may be impossible to verify with certainty. The difference in the likelihood of a confidence crisis would also need to outweigh the benefits offered by pure money. I’ll leave this one to public discourse.
The advantage of pure money is considerable. It can be designed to have whatever monetary properties we want. We can make it as portable, durable, divisible, fungible, scarce, digital and private as we like, because we construct it. So as long as nothing happens which would cause a fatal confidence crisis in a pure money, it would be a much more ideal form of money to have. But as we’ll see later in the series, human nature means that an inevitable confidence crisis in the prevailing money — regardless of whether it is commodity money or not — might be impossible to avoid. Maybe, though, thanks to some technological breakthroughs, it might for the first time be possible to engineer a pure money in such a way as to avoid a confidence crisis occurring, optimally mitigate the damages of one — or even survive them entirely… but that’s for another discussion.
‘Fiat money’ and ‘Credit money’
There are two other categories of money.
Fiat money is money given with a government-given legal status that it can be used and must be accepted as a medium of exchange. Both commodity and ‘pure’ money can be fiat money. For example, if the government legislated that gold was money, then the commodity gold would be be money by fiat. And the fiat money we currently have (our little pieces of paper/plastic), is an example of pure money made money by fiat.
Credit money (which we’ll explore in a future article) is money that is a physical or legal claim on another person or entity. For example, you paying the baker with an IOU which says that I owe the holder of the IOU a cheesecake is an instance of using credit money. Credit money is a claim on debt, not a commodity in itself. For this reason, all credit money is pure (rather than commodity) money. Credit money can also be fiat or non-fiat money.
Semantics — a deeper justification for the “medium of exchange” definition of money
Semantics might not stop us, but if you want them to take up more of your time, I’ve written a little more about them for the interested reader.
In an article covering the philosophy and methodology of defining an economic concept like money, you’ll see the deeper reasons why I chose the specific definition I did — and why if you defined money differently, it wouldn’t even matter.
If you’re already content with the definition of money I’ve chosen, then feel free to move on to the next article in this unfolding series on money.
