What is money?
People are in constant search to satisfy their needs. However, it is very difficult nowadays for us to be able to satisfy our needs alone. It is impossible for a single person to produce everything he needs to have a minimally modern life: it is not possible to obtain time, much less, all the knowledge necessary to learn how to produce everything (HAYEK, 1945). It is natural for each person to be better at some tasks than others, so people specialise in different tasks (MISES, 2008).
To address this, humans have long resorted to specializing in a craft they have an affinity for, trading services rather than doing everything (MISES, 2008). Think, how many of the things you own did you make yourself? Our standard of living today requires countless people to cooperate to produce the goods we use. Barter is nothing more than a tool to make people of different trades cooperate with each other. In short, barter is a direct exchange (MISES, 2013).
Let us take an example: suppose that Jonas is a carpenter specialized in the manufacturing of wooden furniture. This is a time-consuming service and doesn’t fulfill all of Jonas’ needs: he needs food, water, housing, and much more to survive. Food production is also a time intensive process, making it difficult for Jonas to carry out both it and carpentry in his time. However, Maria, who tends to her farm and has an excess of food from her work, is looking for wooden furniture for her house. As such, Jonas and Maria agree to exchange some of the furniture Jonas created for some of the food Maria produced. Commerce is a two-way street: neither Jonas nor Maria can both produce both goods. Instead, they both recognize it would be more efficient for the both of them to specialize in their craft and trade the results. Jonas, because of his carpentry skills and tools, can create wooden furniture more efficiently than Maria. Maria, with her skills and tools, can produce food more efficiently than Jonas. As such, the trade benefits both of them and saves them time.
This was an example considering just two individuals, but, in the real world, the logic extends to many people trading with each other, a large network of specialized tradesmen. We call this network the Market.
A current example of the barter system is that taking place for the FIFA 2022 World Cup Sticker Album. In this exchange, both parties exchange a sticker they don’t need for one they are missing from their album. In doing so, both people get closer to completing their album.
This barter system, however, has limitations. Barter is a direct exchange. As such, it requires both parties to have coinciding desires and things to offer. This restriction greatly limits the number of possible exchanges. As we have discussed, trades occur when people cooperate towards their goals. Therefore, any difficulty that arises in the trading process will hinder the completion of their goals. Barter facilitates this trade, but it leaves more to be desired, a solution that allows for trades to happen indirectly. The solution is a common medium of exchange, money (MISES, 2013).
Money came about to facilitate barter and solve the difficulties that arise from direct exchange (MISES, 2013). The money acts as a kind of universal gift card, allowing people to cooperate with each other even if the member trading with them does not possess the direct goods or service they want. Remember: exchanges happen so that people can get what they need (since producing everything they want alone is impossible). Facilitating this exchange means facilitating the fulfillment of human needs. So money is used as this common medium of exchange (MISES, 2013).
Money can be anything, as long as it’s scarce and people accept it as common medium of exchange. In the past, people have used salt (hence the term salary), tobacco, shells, or even stones (Yap Island), among other things. However, in the evolutionary process of the market, two precious metals were chosen by several civilisations as common medium of exchange, these metals were gold and silver (MISES, 2008).
For money to be considered good, it must meet these characteristics:
- Desirable: Needs to be accepted and desired by people. After all, it is intended to be a medium to facilitate trade. If no one wants it, trade won’t happen.
- Divisibility: Needs to be divisible into smaller units. 100 Leonscoins, 50 Leonscoins, 20 Leonscoins, 10 Leonscoins, 1 Leonscoin, 50 Leonscents etc.;
- Serves as a store of value: to serve its purpose, money cannot lose value quickly. If it loses its purchasing power in a couple days, then it cannot be used as an intermediary in later transactions;
- Unit of account.
FUNCTION OF MONEY
Let us use the example of Jonas to highlight how money is useful to facilitate trade.
Jonas, the carpenter, manufactures furniture and sells it for a certain price. With each sale, he earns money to buy what he needs. The people he will buy from will happily accept the currency for their product and will use it to buy whatever goods or services they need. Because of money, Jonas does not need a specific seller he wants to buy from to want his furniture; as long as someone purchases his furniture, he will earn money and be able to acquire the goods he wants, and so on.
If we couldn’t exchange your money for goods and services, it would basically be worthless. If no one accepted that good as media of exchange, its value would plummet.
Money — a common medium of exchange — has the important mission of facilitating human cooperation and that is why it is essential that people understand what money is and what it is not, and that was the question we sought to answer in this article.
HAYEK, F.A. von: The Use of Knowledge in Society. American Economic Review, 1945.
MISES, L. H. E. von: Human Action: A Treatise on Economics. 4th Rev ed. San Francisco: Fox & Wilkes, 2008.
MISES, L. H. E. von: The Theory of Money and Credit. New York, NY: Skyhorse Publishing, 2013.