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24 1 What Is Money? Principles of Economics


Other examples of goods that have been used as commodity money include copper, corns, tea, shells, cigarettes, wine, etc. Several forms of commodity money were employed relative to the needs that certain economic circumstances created. These additional assets are known as near-money and are not as liquid as those covered by the M1. Individuals may also debase gold or silver coins by clipping the edges or filing off shavings from coins, melting those small amounts down, and selling them. This results again in coins in circulation that contain less precious metal than indicated. Generally, the value of commodities is less volatile, but there is always the risk that they may lose value.

What’s an example of commodity money?

Early forms of money were often commodity money-money that had value because it was made of a substance that had value. Examples of commodity money are gold and silver coins.

Most modern paper currencies are fiat currencies, including the U.S. dollar, the euro, and other major global currencies. Commodity money has some intrinsic value due to the content of precious metal it is made up of or backed by, but debasement or increases in precious metal supply can cause inflation. Commodity money in the time of high inflation can be used as a buffer as commodities have a value of their own, which currencies do not have. •More macro-economically sophisticated synthetic commodity monies could supply the basis for uniquely stable monetary regimes.

Types of money and monetary aggregates

The difference between fiat money and commodity money relates to their intrinsic value. Historically, commodity money has an intrinsic value that is derived from the materials it is made of, such as gold and silver coins. Fiat money by contrast, has no intrinsic value – it is essentially a promise from a government or central bank that the currency is capable of being exchanged for its value in goods. Commodity-based currencies were volatile due to the regular business cycle and periodic recessions.

  • Moreover, the Russian ruble and Chinese “flying money” are some instances of unsuccessful fiat currencies over the years.
  • The logical way to reconcile the accounting then is to credit the material value of the token to the State’s balance sheet, even though the bearer has physical possession of the token.
  • Fiat and commodity money are different because commodity money is backed up by the intrinsic value of the commodity from which it is made and fiat money is only backed by government authority.
  • Consider a $20 bill that you accidentally left in a coat pocket a year ago.
  • Melting thus transforms a financial asset into a real asset from the bearer’s point of view.
  • Money actually derives its value from the functions it allows, such as a medium of exchange, storehouses of wealth, or a unit of measurement.

While it is true that all money in an economy serves three functions, not all money is created equal. Cryptocurrencies share many similarities with conventional fiat money, but also offer some interesting advantages. President Richard Nixon ended the gold standard in the United States in 1971, when he fixed the rate at $38 dollars per ounce of gold and said that dollars could no longer be redeemed with gold. The values of gold and the USD were decoupled entirely in 1976. The earliest forms of money, like agricultural goods and seashells, were concrete, as they represent an immediate utility that can be consumed. This later changed to metal coins, where the underlying materials (i.e. metal) were capital goods (i.e., used in the production of equipment).

Commodity money

The additional $900 has been generated as debt by the bank and reflects commercial bank money. Commercial bank money refers to money in an economy that is created through debt issued by commercial banks. Banks take client deposits into savings accounts and then loan a portion to other clients. The reserve requirement ratio is the portion banks cannot lend to different clients from their savings accounts. The lower the reserve requirement ratio, the more funds will be loaned to other people, creating commercial bank money. Because it has not been recognized as legal tender by GALA the government, as opposed to fiat money, individuals are not obligated to accept it as a form of payment under the law as a result.


These types of notes were issued particularly in Pennsylvania, Virginia and Massachusetts. Such money was sold at a discount of silver, which the government would then spend, and would expire at a fixed date later. Fiat money is a medium of exchange that is backed by the government and nothing else.

When that happens, as it did in Russia in the 1990s, people tend to look for other items to serve as money. In the case of Russia, the U.S. dollar became a popular form of money, even though the Russian government still declared the ruble to be its fiat money. Gold and silver are the most widely used forms of commodity money. Gold and silver can be used as jewelry and for some industrial and medicinal purposes, so they have value apart from their use as money.

It is important to know how the concept of commodity money came into existence and also about the usage of commodity money in ancient and medieval times. Commodity money was in use for thousands of years, in times when the barter system still prevailed before any other form of money or currency came into circulation. Goods perceived to be of equal value were exchanged between the buyer and seller. For example, a pound of sugar was exchanged for an amount of coffee. In this situation, both sugar and coffee are commodities that have intrinsic values of their own and when exchanged for each other play the role of money. The term money, as used by economists and throughout this book, has the very specific definition given in the text.

Currently, most developed nations use a form of fiat money as their mode of payment. For fiat currencies to be successful, the nations must control both counterfeiting and management of monetary supply. Back in the day of the gold reserve, they printed money out of a valuable physical commodity such as gold, silver, or paper money they could redeem for a set amount of the gold or silver. Fiat money gives central banks more control over the amount and frequency of credit extensions because the control of fiat money allows the banks to “print” more money. The value of fiat money is determined by supply and demand, and it was created as a substitute for commodity money and representational money in the early 20th century.

Examples of commodity money includes commodities such as gold, silver, copper. Another important concept to know is that fiat currency is legal tender. Being a legal tender means that it is recognized by law to be used as a payment method. Everyone in the country where a fiat currency is recognized as a legal tender is legally obliged to accept or use it as payment. Before 1970, the world was governed by the gold standard, which allowed people to swap the currency they owned for gold at any time. Countries that adhered to the gold standard established a fixed price for gold and traded gold at that price, therefore maintaining the gold standard.

Explain the difference between commodity money and fiat money.

The conventional dichotomy of “” and “fiat” base monies overlooks a third possibility that shares some features of each. This third type, which I call “synthetic commodity money,” resembles fiat money in having no nonmonetary value; but it resembles commodity money in being not just contingently but absolutely scarce. For example, it is now possible to transfer money from your savings account to your checking account using an automated teller machine , and then to withdraw cash from your checking account. Thus, many types of savings accounts are easily converted into currency. When a central bank issues banknotes, it is simultaneously issuing you, the consumer, a percentage of your government’s debt. Think about how, for example, the EU and the United States create money.

  • There will always be a demand for gold as it can be used in jewelry, making computers, Olympic medals, etc.
  • The United States Dollar , the Euro and most other major currencies are fiat monies.
  • Everyone in the country where a fiat currency is recognized as a legal tender is legally obliged to accept or use it as payment.
  • You may obtain access to such products and services on the App.
  • CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage.
  • If the gap becomes too negative, the public will hoard the tokens, or it will convert them to their material use and thus end their role as money.

She teaches economics at Harvard and serves as a subject-matter expert for media outlets including Reuters, BBC, and Slate. Identify and explain three reasons why the AS curve will be upward sloping in the short-run. Please note that an investment in crypto assets carries risks in addition to the opportunities described above. This article does not constitute investment advice, nor is it an offer or invitation to purchase any crypto assets. Marketing automation is a type of software that allows companies to effectively target customers with automated marketing …

Bitcoin Price History: 2009 – 2023 – Bitcoin Magazine

Bitcoin Price History: 2009 – 2023.

Posted: Thu, 02 Mar 2023 14:28:32 GMT [source]

To conclude, bitcoin fulfils most qualities as ideal money. Its supply is also fixed in contrast to that of fiat currency. Bitcoin is also neither commodity money , representative money , nor fiat money .

Suppose, for example, that you have $100 in your and you write a check to your campus bookstore for $30 or instruct the clerk to swipe your debit card and “charge” it $30. In either case, $30 will be transferred from your checking account to the bookstore’s checking account. Notice that it is the checkable deposit, not the check or debit card, that is money.

In Romania under Communist Party rule in the 1980s, for example, Kent cigarettes served as a medium of exchange; the fact that they could be exchanged for other goods and services made them money. First, one objection to fiat money is the lack of intrinsic value, and opponents of fiat money often claim that a system using fiat money is inherently fragile because fiat money doesn’t have a non-money value. Since then, the international monetary system has transited into the era of fiat currency.

What are the 7 commodities?

Estimating the Role of Seven Commodities in Agriculture-Linked Deforestation: Oil Palm, Soy, Cattle, Wood Fiber, Cocoa, Coffee, and Rubber.

It can be converted to fiat and commodity money only by selling it, a time-consuming and costly process. Consider a $20 bill that you accidentally left in a coat pocket a year ago. Value has, in effect, been “stored” in that little piece of paper. We can understand the significance of a medium of exchange by considering its absence.


Explain how the Fed can achieve a federal funds rate target of 1.5% if the federal funds rate is currently at 2%. Some countries started to frequently devalue their currency or even cancel the peg to the US dollar. There was a return to the gold standard in the late 1920s to early 1930s as a result of The British Gold Standard Act of 1925. However, the return of the gold standard led to a recession, unemployment, and deflation in these economies. This state of affairs lasted until the Great Depression (1929–1939) forced countries off the gold standard.


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