Money

What you’ll learn to do: explain what money is and what makes it useful

When we think of money, what comes to mind is usually the the paper bills in our wallet or the coins in our pockets. But money is much more than that. How we define money determines where and how we use it to obtain the goods and services that businesses offer the consumer. In this section we'll look at what money is, why it's useful, and what it may be in the future. 

What Is Money?

Money is really anything that people use to pay for goods and services and to pay people for their work. Historically, money has taken different forms in different cultures—everything from salt, stones, and beads to gold, silver, and copper coins and, more recently, virtual currency has been used. Regardless of the form it takes, money needs to be widely accepted by both buyers and sellers in order to be useful.

Barter and the Double Coincidence of Wants

To understand the usefulness of money, we must consider what the world would be like without money. How would people exchange goods and services? Economies without money typically engage in the barter system. Barter—literally trading one good or service for another—is highly inefficient for trying to coordinate the trades in a modern advanced economy. In an economy without money, an exchange between two people would involve a double coincidence of wants, a situation in which two people each want some good or service that the other person can provide. For example, if a hairstylist wants a pair of shoes, she must find a shoemaker who has a pair of shoes in the correct size and who is willing to exchange the shoes for a certain number of hairdos. Such a trade is likely difficult to arrange. Think about the complexity of such trades in a modern economy, with its extensive division of labor that involves thousands upon thousands of different jobs and goods.

Another problem with the barter system is that it doesn't allow people to easily enter into future contracts for the purchase of many goods and services. For example, if the goods are perishable, it may be difficult to exchange them for other goods in the future. Imagine a farmer wanting to buy a tractor in six months using a fresh crop of strawberries. Also, while the barter system might work adequately in small economies, it will limit growth. Specifically, time that individuals might otherwise spend producing goods and services and enjoying leisure time is spent bartering.

Functions of Money

Money solves the problems created by the barter system. First, money serves as a medium of exchange, which means that money acts as an intermediary between the buyer and the seller. Instead of exchanging hairdos for shoes, the hairstylist now exchanges hairdos for money. This money is then used to buy shoes. To serve as a medium of exchange, money must be very widely accepted as a method of payment in the markets for goods, labor, and financial capital.

In addition, money needs to have the following properties:

1. It must be divisible—that is, easily divided into usable quantities or fractions. A $5 bill, for example, is equal to five $1 bills. If something costs $3, you don’t have to tear up a $5 bill; you can pay with three $1 bills.
2. It must be portable—easy to carry; it can’t be too heavy or bulky.
3. It must be durable. It can't fall apart or wear out after a few uses.
4. It must be difficult to counterfeit. It won’t have much value if people can make their own.

Second, money must serve as a store of value. Consider the barter between the hairstylist and shoemaker again. The shoemaker risks having his shoes go out of style, especially if he keeps them in a warehouse for future use—their value will decrease with each season. Shoes are not a good store of value. Holding money is a much easier way of storing value. You know that you don't need to spend it immediately, because it will still hold its value the next day or the next year. This function of money doesn't require that money is a perfect store of value. In an economy with inflation, money loses some buying power each year, but it remains money.

Third, money serves as a unit of account, which means that it's the ruler by which other values are measured. For example, a hairstylist may charge $30 to style someone's hair. That $30 can buy two shirts (but probably not a pair of shoes). Money acts as a common denominator, an accounting method that simplifies thinking about trade-offs.

So money serves all of these functions: medium of exchange, store of value, and unit of account.

Commodity versus Fiat Money

Commodity money consists of objects that have value in themselves as well as value in their use as money. Gold, for example, has been used throughout the ages as money, although today it is not used as money but rather is valued for its other attributes. Gold is a good conductor of electricity and is used in the electronics and aerospace industry. Gold is also used in the manufacturing of energy efficient reflective glass for skyscrapers and is used in the medical industry as well. Of course, gold also has value because of its beauty and malleability in the creation of jewelry.

As commodity money, gold has historically served its purpose as a medium of exchange, a store of value, and as a unit of account. Commodity-backed currencies are dollar bills or other currencies with values backed up by gold or another commodity held at a bank. During much of its history, the money supply in the United States was backed by gold and silver. Interestingly, antique dollars dated as late as 1957 have “Silver Certificate” printed above the portrait of George Washington, as shown below. This meant that the holder could take the bill to the appropriate bank and exchange it for a dollar’s worth of silver.



As economies grew and became more global in nature, the use of commodity monies became more cumbersome. Countries moved toward the use of fiat money. Fiat money is legal tender whose value is backed by the government that issued it. The United States’ paper money—like the dollar bill, for instance—carries this statement: “This note is legal tender for all debts, public and private." In other words, by government decree, if you owe a debt, then legally speaking, you can pay that debt with the U.S. currency, even though it's not backed by a commodity. The only backing of our money is widespread faith and trust that the currency has value—and nothing more.

The following video discusses some additional characteristics of money:

Alternatives to Traditional Currency

In his TED Talk, brand strategist Paul Kemp-Robertson notes that non-government currencies are gaining consumer trust and asks the rhetorical question “Is there a reason for governments to be in charge of money?”^[11] Given the proliferation of alternative currencies—from digital coins and wallets to brand point systems and rewards—the answer may, at some point in the future, be “no.” What’s clear in the present is that the process of making purchases and other payments is being transformed, with implications for monetary policy.

What constitutes an alternative currency is open to debate. For our purposes, we’ll consider three categories of currency: cryptocurrencies, mobile commerce and regionally-based currency. A point worth considering is that “currency” and payment processes are being transformed not only by technology—for example, blockchain and mobile technologies and related services—but, as Kemp-Robertson alluded to, by consumer trust (or lack thereof) in the system.

Investopedia defines a cryptocurrency as “a digital or virtual currency that uses cryptography for security.” The most credible cryptocurrencies are those based on blockchain technology that records, validates and stores transaction information across a decentralized and distributed network of personal computers. Although there were earlier versions, the first cryptocurrency to gain broad market attention was Bitcoin, launched in 2009.^[12] Retailer acceptance of bitcoin is still limited to early adopters, including a few major retailers such as Microsoft, Overstock and Newegg.^[13] However, the currency’s volatility—a historical high and low of $20,089 and $65.53 and a range of 4,030.63 over the most current 90 day period—make it more appropriate as a speculative investment than for use as money.

Coinmarketcap.com lists over 2,000 cryptocurrencies with a total market value of roughly $144 billion.^[14] As of March 31, 2019, there were approximately 17.6 million bitcoins in circulation with a total market value of $72 billion.^[15] To put this in perspective, check out The Money Project’s visualization of the world’s money and markets. To excerpt, as of 2017 the value of cryptocurrency was $173 billion compared $7.6 trillion in coin and banknotes, $36.8 trillion in “narrow money” (equivalent to M1) and $90.5 trillion in “broad money” (equivalent to M2).

Given those relative values, what is the perceived impact on monetary policy? In a speech at the 2018 Decoding Digital Currency Conference, Fed Governor Lael Brainard stated that “the still relatively small scale of cryptocurrencies in relation to our broader financial system and relatively limited connections to our banking sector suggest that they do not currently pose a threat to financial stability.”^[16] While recognizing that cryptocurrencies “represent the leading edge” of digital technologies for payments, she also noted that the extreme fluctuations in asset value limit the currency’s ability to serve as a “stable store of value” and “meaningful unit of account,” two essential functions of money. Addition factors highlighted as risk factors for potential uses:

• Cryptocurrency is not backed by the faith and credit of a trusted individual or institution
• Cryptocurrency is not legal tender (has limited acceptance)
• There is no central authority with responsibility for the maintenance, security or reliability of the  technology or ecosystem
• There is currently no legal framework to provide recourse for consumers impacted by fraud, theft or other security breach

Reporting on a survey of central banks, the Bank of International Settlements (BIS) found that the majority (58%) reported public adoption of cryptocurrency as minimal (“trivial/no use”), with 28% reporting niche use and 14% do not know; there were no responses to either of two additional options: “Significant use” and “Wider public use.” Survey responses indicate that most central banks are still evaluating the situation. Of those that expressed an opinion, the majority expected use in payments to remain low due to limited acceptance, perceived user risk and, in some cases, legal prohibitions. The report concluded that “most central banks consider cryptocurrencies to be a niche technology rather than the future of money.”

Mobile Commerce

Mobile payments aren’t a form of currency per se but a means of accessing financial services and conducting transactions on a mobile device. Although the definition of m-commerce differs somewhat based on authority, a working definition is sales transactions made on a smartphone or tablet. Using this definition, research firm eMarketer projects that m-commerce will represent approximately 50% of U.S. e-commerce sales in 2020, up from approximately 35% in 2017. The majority (over 70%) of mobile commerce transactions are made on smartphones, with the remainder on tablets. Statista.com puts this in perspective with a graph showing U.S. mobile retail commerce revenue percentages and dollars from 20113 to 2021. Although mobile’s percent of total U.S. retail sales is still relatively low (roughly 3%, with e-commerce representing approximately 10% of retail sales), the impact of mobile technology is not only at the point of sale. Forrester Research estimates that by 2022, m-commerce will impact 42% of total retail sales. Forrester principal Brendan Miller, “shoppers have integrated smartphones into their product research at every phase of the customer life cycle, from discovery to price checking in-store.”

Factors limiting adoption of mobile wallets include fears about security, limited retailer acceptance, the proprietary nature of apps and what Bluefin refers to as “unnecessary payment friction” caused by having to switch between mobile wallets based on where a consumer is shopping. Also, in developed countries, there isn’t a compelling point of pain that would prompt a switch to mobile payments. Visa and MasterCard are widely accepted and use isn’t limited by type of device or operating system as is true with Apple Pay, Android Pay and Samsung Pay. However, the consensus is that ”as smartphones and internet connectivity reach a saturation point, consumers will likely start to view their phones more as banking and shopping devices.”^[17] For perspective, mobile wallet transactions are expected to total $800 billion in 2019, up from $718 billion in 2017.^[18] As Apple, Google, Samsung and PayPal increase their focus on mobile payments, and merchants ramp up their mobile capabilities.

The fastest growth in mobile money services is in underbanked markets in Africa, Asia and Latin America. The World Bank reports that 69 percent of adults now have access to a bank account or an account through a mobile money provider. World Bank President Jim Yong Kim expresses the economic development view, stating “Having access to financial services is a critical step towards reducing both poverty and inequality, and new data on mobile phone ownership and internet access show unprecedented opportunities to use technology to achieve universal financial inclusion.”^[19] However, the implications may be greater for marketers who now have access an additional 3.8 billion people. Indeed, given that lack of central bank comment on mobile commerce, the primary implications will be for the major technology players, marketers and retailers.

Regionally-Based Currency

Regions develop “currencies” to support a range of local economic development and sustainability initiatives. According to The Schumacher Center for a New Economics, a non-profit promoting local resilience, “Centralized currency issue serves centralized production whereas regional currencies represent a democratization of currency issue, supporting local businesses and educating consumers about how their money circulates in the local economy.”^[20]

The Center has been involved in the development of a number of local currencies, including BerkShares, a currency specific to Western Massachusetts. Launched in 2006 and still in operation, The New York Times referred to the BerkShares program as a "great economic experiment." The program currently involves a network of four community banks, approximately 400 locally owned business and local citizens. BerkShares can be obtained at participating bank branches at an exchange rate of $0.95 to one BerkShire and BerkShares can be exchanged for U.S. dollars at the same exchange rate. BerkShares can be spent at face value—that is, 100 BerkShares equals $100—with participating businesses and can be used by private parties as payment for services, if desired.

There are a number of active regional currency systems in operation in the United States and internationally. Refer to the Schumacher’s Active Programs page for summaries of the initiatives. Although this last category of currency doesn’t have systemic (i.e., monetary policy) impact at the current scale, the potential community impact is worth considering if you’re a local business, non-profit or promoting regional economic development.

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