The Different Types of Money
Money, Its Forms and Functions
Though money is ubiquitous in today’s society, its strict definition can be difficult to pin down. Many economists have approached the analysis of money from various perspectives. In the 19th Century, William Stanley Jevons famously identified four functions of money. Money is used as: a unit of account, a medium of exchange, a standard of deferred payment, and a store of value. When money is used to measure the market value of goods and services, it performs its function as a unit of account. By fulfilling this function, money becomes the standard of price of goods and services that are unlike each other. This allows money to be used in the exchange of goods and services. Money can also be used as an accepted standard for the settlement of debts. When money can be reliably stored and retrieved while maintaining value over time, then it can be used as a store of value.
For money to fulfill these four functions in the most convenient way, money must have the following characteristics.
Durability: Money must stand up to physical wear and tear
Portability: Money must be easily transported and transferred
Divisibility: Money must be able to be divided
Fungibility: Every unit of money must be easily interchangeable with other units of money
Limited supply: The supply of money must be limited in order to retain value
Acceptability: Money must be easily identifiable and accepted
Stability of value: The value of money must be constant over long periods of time
Different types of money have been used throughout history. Not all types of money may intrinsically nor perfectly exhibit all seven characteristics, meaning not all types of money can fulfill the four functions of money in the most effective way. Considering this, the widespread use of a certain type of money over another may entail certain trade offs related to the characteristics which a given type of money has.
COMMODITY
Commodity money is money in its earliest form. The value of commodity money comes from the value of the commodity itself. Precious metals such as gold, silver, or bronze are historical examples of commodity money which are intrinsically scarce.
REPRESENTATIVE
Representative money has no intrinsic value, but has value which is backed by a commodity. A certificate representing the ownership of gold is an example of representative money. The earliest bank notes backed by gold reserves were also forms of representative money.
FIAT
Fiat money is money which is not intrinsically scarce, meaning that its value is tied to authoritative decisions by a governing body. The acceptability of fiat money is based on a legal decree.The US dollar is the prime example of such money. The stability of its value also depends on the decisions made by the governing body. Unlike commodity money whose value is determined by its market exchange value, the real value of fiat money is in purchasing power.
FIDUCIARY
Fiduciary money comes in the form of checks and bank drafts which are exchanged for fiat or commodity money. The value of fiduciary money is based on trust in the promise that it will be exchanged.
COMMERCIAL BANK MONEY
Commercial bank money is money created through fractional reserve banking, where banks incur debt to loan out deposited money. Commercial bank money is essentially debt generated by a commercial bank that can be exchanged for other types of money or used to buy goods and services.
Of the five types of money, fiat money and commodity money are distinct from the rest in that, unlike the others, neither call for the existence of another form of money that is already under exchange. For this reason, fiat and commodity money have historically been used as base money.
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