by Elvis Shera
This article is part of the weekly section “Financial Education,” where we explore various aspects of economics and personal finance. In this installment, we examine the characteristics of money and how it has evolved throughout history. In the next article, we will explore how technological development impacts the value and means of transferring money. If you have other topics you would like to see covered, don’t hesitate to write to us.
In the article “What is Money?”, we showed how money naturally manifests in a society through the dynamics of the free market and how, throughout history, the market has chosen different goods as a medium of exchange. In this piece, we will delve deeper into the characteristics that distinguish those goods that can be considered candidates for money.
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Characteristics of Money
Clearly, the first characteristic of money is being a medium of exchange. This is the fundamental and primary characteristic. We can exchange it now or at a later time when we need goods or services. Exchanging at a future moment imposes the second characteristic of money, which is “conservation of value over time.” Preserving money over time significantly reduces the number of candidate items that can be used as money. Food, for example, does not last long, and even some metals like iron, although more durable, eventually oxidize by reacting with various elements and wear out over time.
These items, when needed, would not be able to facilitate exchange due to their degradation. The third characteristic is: the item used as money must have value to be accepted in exchange. Value is a relative concept, but we can agree that a rare item is one that has value. Common stones withstand time, but the land is full of stones, and every market actor can possess stones in abundance, which would not benefit from exchanging these stones and would not use them as a medium of exchange. Naturally, a sheep has value because it provides meat, wool, milk, and the question is: why would you exchange a sheep with someone who gives you stones in return when you already have plenty of stones? Therefore, to facilitate the exchange of goods or services with money, the object used as money must be “rare.” Rare to the extent that people cannot easily create it in the quantity they want and provides assurance that in the future the value it has today will be preserved, and this can only be done by a rare commodity.
Stones have been used as money. An interesting example is the large stones that were used as money on the island of Yap in Polynesia. These stones were rare, preserved over time, and served as a medium of exchange by fulfilling the three stated conditions in a confined place such as an island.
On an island where everything is static and distances are not large, the stones did not move from their place. This was a natural choice because stones have great weight and were as tall as a person. What happened was a transfer of ownership title according to the next exchange and recording the exchange in a public register.
Such a system works well on an island, but imagine now going from a small island, with a contained economy, to the continent. On the continent, distances are much larger, and exchanges need to be made between people with different cultures and languages. The question is: Who among them will hold the stones after the exchange? Unlike the island, it is necessary to transfer the stones from one actor to another, even over long distances. Naturally, it is impossible to move large stones and transport them over distances with high frequencies every time exchanges are made.
Read also: What is Money?!
This mental experiment leads us to the fourth characteristic. The object that takes the role of money must be “easily transportable.” To achieve this, the object, in addition to fulfilling the other mentioned conditions, must contain relatively high value in a small volume. Preferably, it should fit within clothing to avoid attracting attention, as it would pose a security risk to the holder.
Let’s continue now with the same example and the hypothesis that large stones were transferred over distance, and weight is not a problem. Consider now the case where the stone has a higher value than the goods or services received. How will the exchange be made in these cases? The first idea is to have stones of different sizes, but in these circumstances, the sizes were limited, and smaller stones gathered together did not create the value of a large stone. Another thought is the division of the large stone into pieces as needed, but these stones cannot be divided because they would lose value, meaning it was no longer possible to gather the pieces of the stone to form the initial value. This problem of division projects us directly into another characteristic that the object must fulfill to be considered money. It must “be divisible” into smaller parts, where the smaller parts can be gathered again and form the initial value, meaning the division does not create a loss of value.
The final element that is necessary for money is its capacity to serve as a “unit of measure and unit of account.” This means it is used as a standard tool to measure the value of goods and services in an economy. This allows the prices of products and services to be expressed in money, making it easy to compare their value. If bread costs 100 Lek and a bottle of water 50 Lek, you know that bread costs twice as much as water. Also, 1000 Lek in my pocket is no different from 1000 Lek in your pocket and can buy the same things.
The unit of account is essential for the functioning of an economy because it facilitates trade agreements. Without a common unit of account, it would be much harder for people to compare prices. This, for example, is a strong reason why gold dominated for a long time. Precisely because it could create coins that looked the same from each other and with the same weight. Also, different denominations, with different weights to create almost any value and for getting change also in coins.
Let’s summarize once again what the characteristics an object must have to be used as money:
- Medium of exchange
- Conservation
- Rarity
- Transportability
- Divisibility into smaller parts
- Unit of measure and unit of account
In addition to these properties, we can say that money is also a means of expression. In fact, when we buy something, we are giving a vote or a preference for a good or service and we do this every day. Think about this aspect of money because it is something very important. Perhaps the characteristic that is talked about the least and at the same time the most important.
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In the next article, we will discuss how technological development changes the value or the means of transporting value.
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