The Definition of Money

• John Vandivier

I just realized I haven't actually posted an article defining money. Or at least I can't find one on my own site. Anyway, here is one.

The Classical Definition

Money is classically defined as having three essential elements. Money is a:

Money is the thing you give to people in exchange for other things. Clearly then, it is a medium of exchange. It is also a store of value because nothing would be given in exchange for money if it did not have a value. That is not to say that the value of money cannot fluctuate; indeed, it can. Rather, it is to say that at all times money is money, it has some value.

The opposite is also true, anything which has value can be used as money so long as it can be traded. Money need not be currency, legal tender or charta. Currency is a good which is not significantly useful outside of its role as money. Other goods, however, such as precious metals, can be both currency and otherwise useful.

A good which can be used in its own right or be employed significantly well as money is called a <a href="http://en.wikipedia.org/w/index.php?title=Commodity_money&oldid=597005986">commodity money. Throughout history there have been a range of commodity monies including precious metals, shells, alcohol and cigarettes.

Finally, money is a unit of account. By virtue of a transaction, whatever is given as money can be considered a unit. The single unit may be further divisible, but it need not be. A tautological characteristic of account is established. As we will see, further divisibility is desirable but is not at first necessary in the definition of money.

One last note before I continue. The idea that money serves as a unit of account and stores value means that there is a finite supply of money. If there were an infinite supply of money, no particular amount of money could hold value or provide a meaningful measure of account.

One last last note: The economist's definition of money is not always the same as the legal or institutional definition of some organization such as a bank and so on. The economist's definition of money is more useful for understanding how economies work, and dare I say a more accurate definition in general, but as a matter of practice you should always understand the practical definition of money used by whatever organization with which you are interacting. Often, currency.

"Good Money" vs Money

It's clear that there is a large range of things which can in a technical sense be referred to as money according to the classical definition. Conceivably, any transferable thing could be considered money. Even information can be considered money under the right conditions!

As an aside, the idea that information could act as money does not contradict the idea that there must be a finite supply of money. There is actually a finite supply of information in the universe. Mind blowing, I know. I digress.

While money can be many things, not all money is created equal. There are a variety of factors which are outside of the definition of money, but still make money more or less useful in practice. These include:

  • Divisibility - A single unit may be converted into multiple, smaller units, without compromising the value of any unit.
  • Fungibility
  • Verifiable - Sometimes called \"recognizable,\" or \"recognisability,\" especially in academic works. In industry (the money services industry, that is), this is referred to as verification or identifiability. When money is verifiable it means that the money is easily recognizable as money, and that it intrinsically combats fraud including counterfeiting.
  • Transportable - High value per weight, high value per size, even a lack of legal inhibition to locomotion all fall into this category. Money must be transferable. Good money is easily transferable. Being transportable often makes transfer easier.
  • Commonly used - Similar to being verifiable, but importantly related to the network effect.
  • Predictable Value - Earlier I said money should store value, but that the value could change. Ideally, the value would change in a predictable way so as to provide consistency with the free market principal of free information.
  • Many others - In fact, the list is infinite. Any
There is debate about whether money should be stable (Hayek), inflationary or deflationary. I think the only thing we can be certain of, as noted above, is that predictably valued money is ideal, even if the ideal direction of that predictable change is not yet settled.

I am a fan of a constant money supply. This creates a natural deflationary pressure, of which I am a fan. I am not a fan of accelerated or unnatural deflation, such as might occur under a central bank which reduces the money supply. Moreover, I would assert that in the long run money will be deflationary because, as earlier noted, there is a maximum amount of information in the universe, eventually capping the amount of money, even if at some astronomically large level.

I also like free-market and competing currencies and banking systems. Even if a natural deflation is not ideal and I am wrong, I am confident the market will sort it out before any individual, group of scholars, or central bank does.

Finally, I recommend the following two sources for further inquiry: