Representative money

Representative money

refers to money that consists of token coins, other physical tokens such as certificates, and even non-physical "digital certificates" (authenticated digital transactions) that can be reliably exchanged for a fixed quantity of a commodity such as gold, silver or potentially water, oil or food. Representative money thus stands in direct and fixed relation to the commodity which backs it. This is to be distinguished from commodity money which is actually composed of a real physical commodity. It is also distinguished from fiat money, in which the value of the money varies with regard to commodities, according to government dictate (force of arms) in regions where government authority holds sway, or else according to market forces where it does not.

Commodity money 2

One interesting example of commodity money is the huge limestone coins from the MicronesianYap, quarried with great peril from a source several hundred miles away. The value of the coin was determined by its size — the largest of which could range from nine to twelve feet in diameter and weigh several tons. Displaying a large coin, often outside one's home, was a considerable status symbol and source of prestige in that society.

(Owing to the great inconvenience, islanders would often trade only promises of ownership of an individual coin instead of actually moving it. In some cases, coins which had been lost at sea were still used for exchange in this way. These agreements could be thought of as a kind of representative money, described below.) island of

Once a commodity becomes used as money, it takes on a value that is often different from its intrinsic worth or usefulness. Having the property of money adds an extra use to the commodity, and so increases its value.

This extra use is a convention of society, and the scope of its use as money within the society affects the value of the monetary commodity. So although commodity money is real, it should not be seen as having a fixed value in absolute terms.

To a large extent its value is still socially determined. A prime example is gold, which has been valued differently by many different societies, but perhaps valued most by those who used it as money. Fluctuations in the value of commodity money can be strongly influenced by supply and demand, whether current or predicted (if a local gold mine is about to run out of ore, the relative market value of gold may go up in anticipation of a shortage).

Money can be anything which the trading parties agree has transferable value, but the usability of a particular sort of money varies widely. Desirable features of a good basis for money include being able to be stored for long periods of time, dense so it can be carried about easily, and difficult to find on its own so it is actually worth something.

Metals like gold and silver have been used as commodity money for thousands of years, being in the form of metal dust, nuggets, rings, bracelets and assorted pieces. Eventually the Lydians began coining gold and silver around 560 BC.

Gold and silver are both quite soft metals, and coins minted from the pure metals suffer from wear or deformation in daily use. Fortunately these metals are also easily alloyed with a less expensive metal, frequently copper, to improve durability of the resulting coins. Typically alloys of coinage metals, such as sterling silver or 22 carat (92%) gold, are used to make coins more durable. These are alloys of 90% or more precious metal, for alloys of less than 90% do not improve hardness or durability much, and so are typically considered to be liable to fall into monetary debasement.

Commodity money

Many early instances of money were objects which were useful for their intrinsic value as well as their monetary properties. This has been called commodity money; historical examples include iron nails (in Scotland), pigs, rare seashells, whale's teeth, and (often) cattle. In medieval Iraq, bread was used as an early form of currency.

The use of shells or ivory was nearly universal before humans discovered how to work with precious metals; in China, Africa, and many other areas, use of cowrie shells was common. In China the use of cowrie shells was superseded by metal representations of the shells, as well as representations of metal tools. These imitations may have been the precursors of coinage.

Salt and spices have been used as money. From 550 BC, accepting salt from a person was synonymous with receiving a salary, taking pay, or being in that person's service. Definite indications are available that both black and white pepper have been used as commodity money for hundreds of years before Christ, and several centuries thereafter. Being a valuable commodity, pepper has naturally been used as payment. Alaric I reportedly demanded 3,000 pounds in weight of pepper in 408 AD as part of a ransom for the city of Rome. In the Middle Ages, there was a French saying, 'As dear as pepper'. In England, rent could be paid in pounds of pepper, and so a symbolic minimal amount is known as a "peppercorn rent".

Even in the modern world, in the absence of other types of money, people have occasionally used commodities such as tobacco as money. This happened on a wide scale after World War II when cigarettes became used unofficially in Europe, in parallel with other currencies, for a short time. It also occurs in some remote parts of countries such as ColombiaBolivia, where cocaine, or its precursor, coca paste, is used as commodity money. and

Another example of "commodity money" is shell money in the Solomon Islands. Shells are painstakingly chipped into rough circles, filed down, and threaded onto large necklaces, which are then used during marriage proposals; for instance, a father may charge twenty shell money necklaces for his daughter's hand in marriage.

History of money

The history of money is a story spanning thousands of years. Related to this, Numismatics is the scientific study of money and its history in all its varied forms.

Money itself must be a scarce good. Many items have been used as money, from naturally scarce precious metals and conch shells through cigarettes to entirely artificial money such as banknotes. Modern money (and most ancient money too) is essentially a token — in other words, an abstraction. Paper currency is perhaps the most common type of physical money today. However, goods such as gold or silver retain many of money's essential properties.

Contents

The emergence of money

The use of proto-money may date back to at least 100,000 B.C. Trading in red ochre is attested in Swaziland, from about that date, and ochre seems to have functioned as a proto-money in Aboriginal Australia. Shell jewellery in the form of strung beads would have served as good with the basic attributes needed of early money. In cultures where metal working was unknown, shell or ivory jewellery were the most divisible, easily storable and transportable, scarce, and hard to counterfeit objects that could be made. It is highly unlikely that there were formal markets in 100,000.Before Present(any more than there are in recently observed hunter-gatherer cultures).

Nevertheless, proto-money would have been useful in reducing the costs of less frequent transactions that were crucial to hunter-gatherer cultures, especially bride purchase, splitting property upon death, tribute, and intertribal trade in hunting ground rights (“starvation insurance”) and implements. In the absence of a medium of exchange, all of these transactions suffer from the basic problem of barter — they require an improbable coincidence of wants or events.

Jewellery has often been used for currency and wealth storage in some historical and contemporary societies, especially those in which modern forms of money are scarce, in addition to being used for decoration and display of status and wealth.

In cultures, of any era, that lack money,bartering and some system of in-kind "credit" or "gift exchange" would be the only ways to exchange goods. Bartering has several problems, most notably the coincidence of wants problem. If one wishes to trade fruit for wheat, it can only be done when the fruit and wheat are both available at the same time and place, which may be for a very brief time, or may be never.

With an intermediate commodity (whether it be shells, rum, gold, etc.) fruit can be sold when it is ripe in exchange for the intermediate commodity. This intermediate commodity can then be used to buy wheat when the wheat harvest comes in. Thus the use of money makes all commodities become more liquid.

Where trade is common, barter systems usually lead quite rapidly to several key goods being imbued with monetary properties. In the early British colony of New South Wales in Australia, rum emerged quite soon after settlement as the most monetary of goods. When a nation is without a fiat currency system it is quite common for the fiat currency of a neighbouring nation to emerge as the dominant monetary good.

In some prisons where conventional money is prohibited, it is quite common for goods such as cigarettes to take on a monetary quality. Gold has emerged naturally from the world of barter again and again to take on a monetary function. It should be noted that the emergence of monetary goods is not dependent on central authority or government. It is a quite natural market phenomenon.

Inflation Accounting

                   Inflation accounting is a financial reporting process that considers the effects of inflation on financial statements. Accounting assumes a stable monetary unit. Financial statements that are not adjusted for changes in the purchasing power of the currency become economically irrelevant. In certain countries experiencing high inflation or hyperinflation, laws or accounting standards require corporate financial statements to be adjusted for changes in purchasing power using a price index.

Measuring unit principle

"One of the basic principles in accounting is “The Measuring Unit principle: The unit of measure in accounting shall be the base money unit of the most relevant currency. This principle also assumes the unit of measure is stable; that is, changes in its general purchasing power are not considered sufficiently important to require adjustments to the basic financial statements.”

Under a historical cost-based system of accounting, inflation leads to two basic problems. First, many of the historical numbers appearing on financial statements are not economically relevant because prices have changed since they were incurred.... Second, since the numbers on financial statements represent dollars expended at different points of time and, in turn, embody different amounts of purchasing power, they are simply not additive. Hence, adding cash of $10,000 held on December 31, 2002, with $10,000 representing the cost of land acquired in 1955 (when the price level was significantly lower) is a dubious operation because of the significantly different amount of purchasing power represented by the two numbers.

By adding dollar amounts that represent different amounts of purchasing power, the resulting sum is misleading, as would be adding 10,000 dollars to 10,000 Euros to get a total of 20,000. Likewise subtracting dollar amounts that represent different amounts of purchasing power may result in an apparent capital gain which is actually a capital loss. If a building purchased in 1970 for $20,000 is sold in 2006 for $200,000 when its replacement cost is $300,000, the apparent gain of $180,000 is illusory.

Market Liquidity

                   Market liquidity is a business, economics or investment term that refers to an asset's ability to be easily converted through an act of buying or selling without causing a significant movement in the price and with minimum loss of value. An act of exchange of a less liquid asset with a more liquid asset is called liquidation. Liquidity also refers both to that quality of a business which enables it to meet its payment obligations, in terms of possessing sufficient liquid assets; and to such assets themselves.

Summary

                    A liquid asset has some or more of the following features. It can be sold (1) rapidly, (2) with minimum loss of value, (3) anytime within market hours. The essential characteristic of a liquid market is that there are ready and willing buyers and sellers at all times. An elegant definition of liquidity is also the probability that the next trade is executed at a price equal to the last one. A market may be considered deeply liquid if there are ready and willing buyers and sellers in large quantities. This is related to a market depth, where sometimes orders cannot strongly influence prices.

                    The liquidity of a product can be measured as how often it is bought and sold; this is known as volume. Often investments in liquid markets such as the stock exchange or futures markets are considered to be more liquid than investments such as real estate, based on their ability to be converted quickly. Some assets with liquid secondary markets may be more advantageous to own, are willing to pay a higher price for the asset than for comparable assets without a liquid secondary market. The liquidity discount is the reduced promised yield or expected return for such assets, like the difference between newly issued U.S. Treasury bonds compared to off-the-run Treasuries with the same term remaining until maturity. Buyers know that other investors are not willing to buy off-the-run so the newly issued bonds have a lower yield and higher price.

                   Speculators and market makers are key contributors to the liquidity of a market, or asset. Speculators and market makers are individuals or institutions that seek to profit from anticipated increases or decreases in a particular market price. By doing this, they provide the capital needed to facilitate the liquidity. The risk of illiquidity need not apply only to individual investments: whole portfolios are subject to market risk. Financial institutions and asset managers that oversee portfolios are subject to what is called "structural" and "contingent" liquidity risk. Structural liquidity risk, sometimes called funding liquidity risk, is the risk associated with funding asset portfolios in the normal course of business. Contingent liquidity risk is the risk associated with finding additional funds or replacing maturing liabilities under potential, future stressed market conditions. When a central bank tries to influence the liquidity (supply) of money, this process is known as open market operations.

Futures

                  In the futures markets, there is no assurance that a liquid market may exist for offsetting a commodity contract at all times. Some futures contracts and specific delivery months tend to have increasingly more trading activity and have higher liquidity than others. The most useful indicators of liquidity for these contracts are the trading volume and open interest.

There is also "dark liquidity", referring to transactions that occur off-exchange and are therefore not visible to investors until after the transaction is complete. It does not contribute to public price discovery.

Banking

                   In banking, liquidity is the ability to meet obligations when they come due without incurring unacceptable losses. Managing liquidity is a daily process requiring bankers to monitor and project cash flows to ensure adequate liquidity is maintained. Maintaining a balance between short-term assets and short-term liabilities is critical. Deposit accounts represent the primary funding (liabilities) in traditional commercial banks, and the loan portfolio represents the primary asset. The investment portfolio represents a smaller portion of assets, and serves as the primary source of liquidity. Investment securities can be liquidated to satisfy deposit withdrawals and increased loan demand. Banks have several additional options for generating liquidity, such as selling loans, borrowing from other banks, borrowing from a Central bank, such as the US Federal Reserve bank, and raising additional capital. In a worst case scenario, depositors may demand their funds when the bank is unable to generate adequate cash without incurring substantial financial losses. In severe cases, this may result in a bank run. Most banks are subject to legally-mandated reserve requirements intended to help banks avoid liquidity crises.

Business

                  In business, the term refers to a company's ability to meet its obligation when and in the event they fall due. If a firm is unable to meet its obligation in time, the company is in danger of insolvency. Therefore, heavy weight is put in finance planning by the controlling staff in order to register all potential shortages in funds. If there is a shortage, the Treasury will be informed in order to be prepared to raise capital for the next business period. If a shortage of funds is registered too late and the funds are insufficient, banks may reject lending a company capital, and in consequence bankruptcy might be inescapeable.

In business, merchants often have liquidation sales, in which inventories are sold at discount to raise cash or to get rid of inventory more quickly.

Equivalization

                   Equivalization is to any mathematical method of comparing two or more generally unlike quantity/value scales.

                   A common example of the utility for an equivalization standard comes in currency markets, where without established exchange rates there is great difficulty making comparisons. For example, Dollars, Euros, Yen have different quantity amounts that would each equal the same implied value. As a solution, an equivalized exchange rate with the United States dollar set as a value = 1 allows for proportional read on the respective values of other currencies compared with it.

                  Without any established equivalization standard, there is no intuitive method for inherently knowing which currency is more valuable than another.

The gold standard was another attempt at equivalizing economic wealth.

Store of Value

                   To act as a store of value, a commodity, a form of money, or financial capital must be able to be reliably saved, stored, and retrieved - and be predictably useful when it is so retrieved.

                   This is distinct from the standard of deferred payment function which requires acceptability to parties one owes a debt to, or the unit of account function which requires fungibility so accounts in any amount can be readily settled. It is also distinct from the medium of exchange function which requires durability when used in trade, and a minimum of opportunity to cheat others.

                   When currency is stable, money can serve all four functions. When it isn't, such as during times of hyperinflation or when complex and volatile forms of financial capital are involved, it becomes important to identify alternative stores of value, of which common ones are:

real estate - actual deeds in protectible land
gold - once the basis of the gold standard
silver - once the basis of the silver standard
precious stones, and precious metals
gold backed currencies, e.g. Swiss franc
collectibles, e.g. original art by a famous artist or antiques
livestock (see African currency)

                   While these items may be inconvenient to trade daily or store, and may vary in value quite significantly, they rarely or never lose all value. This is the point of any store of value, to impose a natural risk management simply due to inherent stable demand for the underlying asset. It need not be a capital asset at all, merely have economic value that is not known to disappear even in the worst situation. In principle, this could be true of any industrial commodity, but gold and precious metals are generally favored because of their demand and rarity in nature, which reduces the risk of devaluation associated with increased production and supply.

Unit of Account

                   A unit of account is a standard monetary unit of measurement of the market value/cost of goods, services, or assets. It is one of three well-known functions of money. It lends meaning to profits, losses, liability, or assets.

                   The accounting monetary unit of account suffers from the pitfall of not being necessarily a stable unit of account over time.

Uses
                 A standard unit of account allows meaningful interpretation of prices, costs, and profits, so that an entity can monitor its own performance and its shareholders can make sense of its past performance and have an idea of its future profitability. In modern economies, money in the form of currency usually serves the role of the standard unit of account. The use of money, under conditions of price stability, vastly improves the efficiency of market economies.

                 The use of a unit of account in financial accounting allows investors to invest capital into those companies that provide the highest rates of return. The use of a unit of account in managerial accounting enables firms to choose between activities that yield the highest profit.

                  In economics, a standard unit of account is used for statistical purposes to describe economic activity. Indexes such as GDP and the CPI are so broad in their scope that compiling them would be impossible without a standard unit of account. After being compiled, these figures are often used to guide governmental policy; especially monetary and fiscal policy.

                  In calculating the opportunity cost of a policy, a standard unit of account allows for the creation of a composite good. A composite good is a theoretical abstraction that represents an aggregation of all other opportunities that are not realized by the first good. It allows an economic decision's benefits to be weighed against the costs of all other possible goods in that society, without having to refer to any directly. Often, this is most easily accomplished with money.

Medium of Exchange

                   A medium of exchange is an intermediary used in trade to avoid the inconveniences of a pure barter system.

                  In a barter system, there must be a coincidence of wants before two people can trade - they must want exactly what the other has to offer, when and where it is offered, so that the exchange can occur. A medium of exchange permits the value of a good to be assessed and rendered in terms of the intermediary, most often, a form of money widely accepted to buy any other good.

Definition

A good definition of money is this: the most marketable commodity. To be widely marketable, a medium of exchange should possess the following characteristics:
transportability
divisibility
high market value in relation to volume and weight
recognizability
resistance to counterfeiting

                  To serve as a medium of exchange, a good or signal need not have any inherent value of its own, that is, it need not be effective as a store of value in itself. Paper money is a useful medium of exchange in part because it has no such value, thus, it cannot lose that value if damaged, and so damaged paper money is easily replaced. Gold was long popular as a medium of exchange and store of value because it was convenient to move large quantities and was inert, and so would not tarnish or lose weight or value.

From barter to exchange

                  A longer term obligation need not be measured in the same terms as the immediate medium is, that is, the medium need not be a standard of deferred payment. Many currencies in periods of high inflation have become unacceptable as denominations of debt - creditors demand contracts that specify payments in some stable currency such as the US dollar, or a quantity of gold or food perhaps, but continue to use the unstable local currency as the daily medium of exchange. The standard of deferred payment tends to trade at a premium in such circumstances, and some goods are not available to those who deal in the medium of exchange currency only.

                 Although the unit of account must be in some way related to the medium of exchange in use, e.g. coinage should be in denominations of that unit making accounting much easier to perform, it has often been the case that media of exchange have no natural relationship to that unit, and must be 'minted' or in some way marked as having that value. Also there may be variances in quality of the underlying good which may not have fully agreed commodity grading. The difference between the two functions becomes obvious when one considers the fact that coins were very often 'shaved', precious metal removed from them, leaving them still useful as an identifiable coin in the marketplace, for a certain number of units in trade, but which no longer had the quantity of metal supplied by the coin's minter. It was observed as early as Oresme, Copernicus and then in 1558 by Sir Thomas Gresham, that bad money drives out good in any marketplace (Gresham's Law states "Where legal tender laws exist, bad money drives out good money").
                   A more precise definition is this: "A currency that is artificially overvalued by law will drive out of circulation a currency that is artificially undervalued by that law." Gresham's law is therefore a specific application of the general law of price controls. A common explanation is that people will always keep the less adultered, less clipped, sweated, less filed, less trimmed coin, and offer the other in the marketplace for the full units for which it is marked. It is inevitably the bad coins proffered, good ones retained.

                    The fact that a bank or mint has always been able to generate a medium of exchange marked for more units than it is worth as a store of value, is the basis of banking. Central banking is based on the principle that no medium needs more than the guarantee of the state that it can be redeemed for payment of debt as "legal tender" - thus, all money equally backed by the state is good money, within that state. As long as that state produces anything of value to others, its medium of exchange has some value, and its currency may also be useful as a standard of deferred payment among others, even those who never deal with that state directly in foreign exchange.

                    Of all functions of money, the medium of exchange function has historically been the most problematic because of counterfeiting, the systematic and deliberate creation of bad money with no authorization to do so, leading to the driving out of the good money entirely.

                    Other functions rely not on recognition of some token or weight of metal in a marketplace, where time to detect any counterfeit is limited and benefits for successful passing-off are high, but on more stable long term social contracts: one cannot easily force a whole society to accept a different standard of deferred payment, require even small groups of people to uphold a floor price for a store of value, still less to re-price everything and rewrite all accounts to a unit of account (the most stable function). Thus it tends to be the medium of exchange function that constrains what can be used as a form of financial capital.

                  It was once common in the United States to widely accept a check as a medium of exchange, several parties endorsing it perhaps multiple times before it would eventually be deposited for its value in units of account, and thus redeemed. This practice became less common as it was exploited by forgers and led to a domino effect of bounced checks - a forerunner of the kind of fragility that electronic systems would eventually bring:

                  In the age of electronic money it was, and remains, common to use very long strings of difficult-to-reproduce numbers, generated by encryption methods, to authenticate transactions and commitments as having come from trusted parties. Thus the medium of exchange function has become wholly a part of the marketplace and its signals, and is utterly integrated with the unit of account function, so that, given the integrity of the public key system on which these are based, they become to that degree inseparable. This has clear advantages - counterfeiting is difficult or impossible unless the whole system is compromised, say by a new factoring algorithm. But at that point, the entire system is broken and the whole infrastructure is obsolete - new keys must be re-generated and the new system will also depend on some assumptions about difficulty of factoring.

                  Due to this inherent fragility, which is even more profound with electronic voting, some economists argue that units of account should not ever be abstracted or confused with the nominal units or tokens used in exchange. A medium is just that, a medium, and should not be confused for the message.

Economic Characteristics

                   Money is generally considered to have the following characteristics, which are summed up in a rhyme found in older economics textbooks and a primer: "Money is a matter of functions four, a medium, a measure, a standard, a store."

                  There have been many historical arguments regarding the combination of money's functions, some arguing that they need more separation and that a single unit is insufficient to deal with them all. 'Financial capital' is a more general and inclusive term for all liquid instruments, whether or not they are a uniformly recognized tender.

                  A unit of account is a standard numerical unit of measurement of the market value of goods, services, and other transactions. Also known as a "measure" or "standard" of relative worth and deferred payment, a unit of account is a necessary pre-requisite for the formulation of commercial agreements that involve debt.

An effective unit of account is to be:
                     Divisible into small units without destroying its value; precious metals can be coined from bars, or melted down into bars again.
Fungible: that is, one unit or piece must be exactly equivalent to another, which is why diamonds, works of art or real estate are not suitable as money.
A specific weight, or measure, or size to be verifiably countable. For instance, coins are often made with ridges around the edges, so that any removal of material from the coin (lowering its commodity value) will be easy to detect.

Store of value
                   To act as a store of value, a commodity, a form of money, or financial capital must be able to be reliably saved, stored, and retrieved - and be predictably useful when it is so retrieved. Fiat currency like paper or electronic currency no longer backed by gold in most countries is not considered by some economists to be a store of value.

Market liquidity
                  It is important for any economy to move beyond a simple system of bartering. 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 is universally recognised and accepted as the common currency. In this way, money gives consumers the freedom to trade goods and services easily without having to barter.

                  Liquid financial instruments are easily tradable and have low transaction costs. There should be no--or minimal--spread between the prices to buy and sell the instrument being used as money.

MONEY

                   Money is any good or token that functions as a medium of exchange that is socially and legally accepted in payment for goods and services and in settlement of debts. Money also serves as a standard of value for measuring the relative worth of different goods and services and as a store of value. Some authors explicitly require money to be a standard of deferred payment.

                   Money includes both currency, particularly the many circulating currencies with legal tender status, and various forms of financial deposit accounts, such as demand deposits, savings accounts, and certificates of deposit. In modern economies, currency is the smallest component of the money supply.

                   Money is not the same as real value, the latter being the basic element in economics. Money is central to the study of economics and forms its most cogent link to finance. The absence of money causes an economy to be inefficient because it requires a coincidence of wants between traders, and an agreement that these needs are of equal value, before a barter exchange can occur. The efficiency gains through the use of money are thought to encourage trade and the division of labour, in turn increasing productivity and wealth.