Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, sometimes, a standard of deferred payment.
After World War II most countries adopted fiat currencies
Nearly all contemporary money systems are based on fiat money. Fiat money, like any check or note of debt, is without use value as a physical commodity. It derives its value by being declared by a government to be legal tender; that is, it must be accepted as a form of payment.
The money supply of a country consists of currency (banknotes and coins) and, depending on the particular definition used, one or more types of bank money. Bank money, which consists only of records, forms by far the largest part of broad money in developed countries.
Many cultures around the world eventually developed the use of commodity money. The system of commodity money eventually evolved into a system of representative money. This occurred because gold and silver merchants or banks would issue receipts to their depositors – redeemable for the commodity money deposited. Eventually, these receipts became generally accepted as a means of payment and were used as money.
PAPER MONEY – BANKNOTES
Banknotes were first issued in Europe in 1661, and were again also used alongside coins. The gold standard, a monetary system where the medium of exchange are paper notes that are convertible into pre-set, fixed quantities of gold, replaced the use of gold coins as currency in the 17th-19th centuries in Europe. These gold standard notes were made legal tender, and redemption into gold coins was discouraged. By the beginning of the 20th century almost all countries had adopted the gold standard.
After World War II most countries adopted fiat currencies that were fixed to the US dollar. The US dollar was in turn fixed to gold. In 1971 the US government suspended the convertibility of the US dollar to gold. After this many countries de-pegged their currencies from the US dollar, and most of the world’s currencies became un-backed by anything except the governments’ fiat of legal tender and the ability to convert the money into goods via payment.
Market liquidity describes how easily an item can be traded for another item, or into the common currency within an economy. Money is the most liquid asset because it gives consumers the freedom to trade goods and services easily without having to barter.
Currently, most modern monetary systems are based on fiat money. However, for most of history, almost all money was commodity money, such as gold and silver coins. As economies developed, commodity money was eventually replaced by representative money, such as the gold standard, as traders found the physical transportation of gold and silver burdensome.
Commodity money value comes from the commodity out of which it is made. The commodity itself constitutes the money, and the money is the commodity. Examples of commodities that have been used as mediums of exchange include gold and silver.
Representative money is money that consists of token coins, paper money or other physical tokens such as certificates, that can be reliably exchanged for a fixed quantity of a commodity such as gold or silver. The value of representative money stands in direct and fixed relation to the commodity that backs it, while not itself being composed of that commodity.
Fiat money or fiat currency is money whose value is not derived from any intrinsic value or guarantee that it can be converted into a valuable commodity (such as gold). Instead, it has value only by government order (fiat). Usually, the government declares the fiat currency to be legal tender, making it unlawful not to accept the fiat currency as a means of repayment.
These factors led to the shift of the store of value being the metal itself: at first silver, then both silver and gold, and at one point there was bronze as well.
In most major economies using coinage, copper, silver and gold formed three tiers of coins. Gold coins were used for large purchases, payment of the military and backing of state activities.
In Europe, paper money was first introduced in Sweden in 1661. The advantages of paper currency were numerous: it reduced transport of gold and silver, and thus lowered the risks; it made loaning gold or silver at interest easier, since the gold or silver never left the possession of the lender until someone else redeemed the note.
However, these advantages held within them disadvantages. First, since a note has no intrinsic value, there was nothing to stop issuing authorities from printing more of it than they had specie to back it with. Second, because it increased the money supply, it increased inflationary pressures. The result is that paper money would often lead to an inflationary bubble, which could collapse if people began demanding hard money, causing the demand for paper notes to fall to zero.
At this time both silver and gold were considered legal tender, and accepted by governments for taxes. However, the instability in the ratio between the two grew over the course of the 19th century, with the increase both in supply of these metals, particularly silver, and of trade. This is called bimetallism and the attempt to create a bimetallic standard where both gold and silver backed currency remained in circulation occupied the efforts of inflationists. Governments at this point could use currency as an instrument of policy.
By 1900, most of the industrializing nations were on some form of gold standard, with paper notes and silver coins constituting the circulating medium. Private banks and governments across the world followed Gresham’s Law: keeping gold and silver paid, but paying out in notes. This did not happen all around the world at the same time, but occurred sporadically, generally in times of war or financial crisis, beginning in the early part of the 20th century and continuing across the world until. One of the last countries to break away from the gold standard was the United States in 1971.