Changing Face of Money and Money-Like Instruments: How Money Is Created-Valued-Devalued… Future of Money…

Anyone can create money, the problem is getting someone else to accept it ~Hyman Minsky

As important as money is to most people, most take it for granted without giving thought to what it really is, where it comes from, or how it works. We earn it, we spend it, we save it, and some may complain they don’t have enough of it, but few really know much about it. For most people, money, finances, monetary policy… are pretty confusing… 

Many assume the paper bills stuffed in their wallet is money. But, is it? Throughout history, money has taken on many forms and there hasn’t been much agreement on what ‘object’ money is: It really is nothing more than a symbol that represents the value of something: Practically speaking, the value of money represents what it will buy – or its purchasing power. Whatever form it takes, it’s used as an intermediary for trade – or medium of exchange, in order to avoid inefficiencies of barter systems.

Money is generally considered to have the following four characteristics: medium, measure, standard, store. That is, money functions as– medium of exchange, unit of account, standard of payment, and store of value. Money is a vague term and, technically, anything can serve as money.

Historically, many things have served as money, but modern forms of money have evolved to become more complex and institutionalized. In this regard, it’s best to think of money as being the social tool with which we primarily exchange goods and services. In the modern monetary system– fiat money (or paper money) is the form of money we utilize on a daily basis. In strict sense, this paper money is largely a creature of law, e.g., in U.S. paper money takes form of U.S. dollars…

But, what gives these pieces of paper value? It’s helpful to break the demand for fiat money down into two components: First is acceptance value and second is quantity value. Acceptance value represents the public’s willingness to accept something as the nation’s unit of account and medium of exchange. Quantity value describes the medium of exchange’s value in terms of purchasing power, inflation, exchange rates, production value… While acceptance value is generally stable and enforceable by law, quantity value can be quite unstable and result in currency collapse in a worst case scenario…

According to John Keynes; money is the measure of value, but to regard it as having value itself is a relic of the view that the value of money is regulated by the value of the substance of which it is made, and is like– confusing a theatre ticket with the performance…

Money Is Not Wealth Money is simply a tool that allows citizens to exchange and transact in the underlying goods and services. If  government spends money in excess of a nation’s underlying productive capacity it will devalue their money and generate destructive inflation. This would result in too much money chasing too few goods and a potential decline in real living standards.

So, the key for government is to balance the amount of money in the system in order to keep the temperature just right– not too hot and not too cold. For example, visualize the economic system is a machine. Metaphor of a car is useful to understand how all the pieces fit together. Monetary policy is akin to the brake and accelerator pads.

When the central bank raises the ‘Federal Funds Rate’ it does so, typically, to suppress inflationary pressures and, in effect, slows or braking economic activity. Vice versa when the Fed lowers the ‘Federal Funds Rate’, typically, to counteract a swelling in number of underemployed, this decreases borrowing costs across the spectrum of credit products (e.g., loans made on shorter-term basis), thus accelerating economic activity.

Monetary policy is mainly about manipulating short-term interest rates though there are other factors… Modern monetary theory distinguishes among different ways to measure the money supply, reflected in different types of monetary aggregates, using a categorization system that focuses on liquidity of the financial instrument used as money.

Most commonly used monetary aggregates (or types of money) are conventionally designated– M1, M2, M3. These are successively larger aggregate categories: M1 is currency (coins and bills) plus demand deposits (such as checking accounts); M2 is M1 plus savings accounts and time deposits under $100,000; and M3 is M2 plus larger time deposits and similar institutional accounts. M1 includes only most liquid financial instruments, and M3 relatively illiquid instruments…

Market liquidity describes how easily an item can be traded for another item, or into the common currency within an economy. Money is most liquid asset because it’s universally recognized and accepted as common currency. Thus, money gives consumers the freedom to trade goods and services easily without having to barter.

Fiat money or fiat currency is money whose value is not derived from any intrinsic value or guarantee that it can be converted into a valuable commodity (e.g., gold). Instead, it has value only by government order (fiat). Usually, the government declares the fiat currency (e.g., central bank…) to be legal tender, making it unlawful to not accept the fiat currency as a means of repayment for all debts, public and private...

In the article How Money Is Created… And How It Dies by Tyler Durden writes:  The concept of money used to be simple; items of recognized value– initially in form of shells, livestock… then precious metals. At some point, someone decided to print paper currency, but it was widely understood that it had to be backed by something of real value, e.g., gold, silver…

This is oversimplified, but it illustrates the central truth: Money that is created at will, rather than– grown in field, mined from earth, or otherwise subject to supply limits, can be easily degraded. What, then, determines value of money? For some, the worldview and ethics of those in charge of printing presses are obvious answers that are often overlooked. Another is confidence of the people who hold and trade money or claims that are denominated in money…

Fast forward to the modern era– featuring central banks, which allow commercial banks to create money by making loans while keeping other reserves on hand… However, as money market funds, bank CDs… like instruments were created– and became a sizeable portion of the global financial system– then, things got even more complicated. Also, add modern derivatives, which entered the scene in significant way only some 30 years ago, and the picture becomes even murkier.

Money has gotten complex in the modern banking and derivatives era, and old model of money (i.e., mainly product of bank reserves, loans…) is woefully inadequate… More global leaders must know-understand– value of sound economic policy, necessity of sound money, difference between government actions that enable growth and economic stability and those that risk abject ruin. Unfortunately, it appears that few leaders do, currently…

In the article Monetary Policies for a Modern World by Gene Chan writes: There is a lot of misinformation that simply does not reflect the current state of monetary world and misinformation is correspondingly causing a gigantic misallocation of private capital to non-productive uses, and overblown distrust in government’s monetary policies. The best framework for describing system of fiat currencies is ‘modern monetary theory’ (MMT).

The theory itself is actually not very modern– the first iteration was formed in 1920s and called Chartalism– and it’s currently experiencing a revival since it more accurately explains and predicts what is actually being observed in many modern economies... The euro-zone (EU) is an exception– they don’t have a fiscal union at the ‘federal’ level: In other words, the arm of government that spends most of the money (e.g., EU’s national governments– Ireland, Greece…) doesn’t have power to print money (euros).

These countries cannot monetize their euro-denominated debt, which arbitrarily forces them into constraints that regular households and private enterprises experience everyday– need to balance budget and fund expenditures with income. However, in  the current ‘modern monetary system’ (e.g., U.S., Canada, Japan, UK, Switzerland…), the government has no obligation to balance revenue and expense.

In fact, it can spend-on deficits forever, with the only ceiling being the economy’s ability to produce-inflation. In these economies, the government never actually ‘owes’ money in the traditional sense, since they can just print more money… Essentially, the following assumptions hold true for all major developed economies outside the euro-zone:

a) Money is not physically backed by any commodity or pegged to any foreign currencies.

b) Government is sole issuer of money.

c) Government has power to maintain the legal tender status of money (through taxation and court system).

d) Fiscal and monetary arms of the government effectively work as a single unit.

Money has gone from– seashells to gold to paper bills to digits in a computer. Now money is about to evolve again as ‘mobile Internet’ unlocks new consumer behaviors, business opportunities and new concepts of value that are redefining the future of money. Within next decade, smart mobile devices will gain mainstream acceptance as a method of payment and could largely replace cash and credit cards for most online and in-store purchases.

In survey by Elon University and Pew Research; security, convenience, and other benefits of ‘mobile wallet’ systems will lead to widespread adoption of technology for everyday purchases by 2020. But, other experts– expect this process to unfold much slower due to a combination of– privacy fears, desire for anonymous payments, demographic inertia, lack of infrastructure to support widespread adoption, resistance from those with financial stake in existing payment structure…

According to Jerry L. Jordan; just as fiat money replaced specie-backed paper currencies, electronically initiated debits and credits will become the dominant payment modes, creating the potential for private money to compete with government-issued currencies According to James A. Dorn; there is certain inertia in the current fiat money regime: even though persistent inflation has eroded the value of the money over the past 50 years, e.g., 1947 U.S. dollar is now worth only 14 cents…

In the future, however, government fiat money may be placed on the endangered species list as people shift from paper currency to electronic money. Stored-value cards may become a customary circulating medium along with privately supplied digital money stored in computer devices and used over the Internet to facilitate electronic commerce.

The transition from a paper-based monetary system to an electronic payments system– reduces transactions costs, expand markets, empowers people… The speed of that transition and expected benefits, however, will depend on creating an effective legal and secure  infrastructure…

The rules that govern the new monetary universe must be– more transparent, equally applied, consistent with individual freedom… if people are to have trust and confidence in cyber-money…