What is money!?..Really
We use money everyday, to fund our needs our wants and everything else. Its one of those things we just cannot do without. But do we understand what money is? Why is it some of us have a lot of it and others have very little or none of it? It is important that we understand this thing called money in order for us to make sense of its effect in our lives and in the world.
What is Money?
What comes to your mind when you think of money? Blue, red, green paper with figurines of people who have played a part in our country’s history. Maybe a fast car, food, a luxury handbag, a piece of land or business. Whatever it is, we associate money with things that we love and want but money can be defined as something that is generally accepted as a medium of exchange for goods and services (Merriam-Webster).
Did you know that there are different types of money? Shocker right? I hope I won’t loose you here because we are about to go deeper. There are 5 different types of money : Fiat, Commodity, Representative, Fiduciary, and Commercial bank money.
5 Types Of Money
Throughout time, there have been various forms of money from salt and cattle to banknotes and debit cards. Currently, fiat money is the money type being used.
1. Fiat Money
Examples: Banknotes (paper money) and coins
Fiat money (fiat currency) is money whose value is not based on its inherent value but is based on an authoritative decision (fiat) by the governing body. The government declares it as legal tender and it must then be accepted as a form of payment everywhere. Due to not having an intrinsic value, a partially destroyed bill can be replaced by the Central Bank (Bank of Botswana).
2. Commodity Money
Examples: Precious metals (i.e. gold and silver), salt, beads, alcohol
Unlike fiat currency, the value of commodity money is intrinsic; its value comes from the commodity it is made from. If the money is destroyed, it cannot be replaced. It is also probably the earliest form of money. These commodities are used as a medium of exchange and gain their value from the scarcity of the items. Salt used to be a very scarce commodity which had a lot of value but upon it being found everywhere it lost its value. The use of this type of money is like using the barter system where goods and services are exchanged for the like. Unlike the barter system, using commodity money functions as a unit of account that allows you to compare the worth of goods and services.
3. Representative Money
Examples: Certificates, paper money, token coins
Representative money, is exactly that. It represents the money that you have. It could be exchanged for precious metals (like gold) held within a bank vault. It is also easier to carry than the actual money e.g. it is much easier to carry a certificate than to carry a chest of gold or a chest of money.
4. Fiduciary Money
Examples: Cheque, bank drafts
This word is derived from the Latin word fiducia which means “to trust”. Fiduciary money works on the promise and trust that it will be exchanged for fiat or commodity money by the issuer (bank). This includes things like bank cheques which are exchanged for money at the bank.
5. Commercial Bank Money
Example: Funds in a checking account
Commercial money (also known as demand deposits) is a claim against a bank for the purchase of goods and services (through the means of withdrawing in person, check, ATMs, or online banking). It is a debt-created currency by the bank. They create more money through a process called fractional-reserve banking. In this, only a certain percentage of money the bank “has” is held within it. The other percent is given to others in the form of loans, in doing so, the bank makes back more money from the interest and fees charged to customers.
Functions of Money
Money is defined by the three functions (or services) that it provides:
1. A Medium of Exchange
The main and most important function of money is that it can be used in the exchange of goods and services. Without money it would be difficult to put a standard value on different type of goods. Would you be willing to exchange your tractor for toilet paper?
2. Unit of Account
Money acts as a common standard for measuring the value of goods and services. It’s consistent and allows you to easily compare the worth of a P1 sweet to a P20 pack of rice. With money as a common measure, it’s easier to quote and bargain prices.
3. Store of value
Money also serves as a store of value, meaning that it retains its worth over time. It should be able to be saved, stored, and retrieved while still being viable as a reliable medium of exchange. You can save, store and retrieve the P1000 that you placed in the bank. Off course its value can be eroded by inflation but that doesn’t take away the fact that it can be saved, stored and retrieved.
The supply of money
Have you ever heard of the supply of money? They make it seem like someone came with a truckload of money and gave it to people to distribute but its not that at all. The supply of money can be increased and decreased depending on monetary policy which is how the Bank of Botswana influences the supply of money in the economy through various activities such as increasing or lowering the bank rate. So let’s look at it this way. When the Bank Rate is lowered, the intention is for people to have access to more money as their loans would have reduced allowing them to have access to the difference as spending power. This excess that consumers have is likely to be spent in different businesses, whether its building, or partying, buying clothes etc. This effect stimulates businesses cash flow allowing them to either buy more of what’s being demanded and make more money or even hire more people in order to expand the business. This is exactly what the Bank of Botswana tries to achieve every time it lowers the Bank Rate. Sometimes the desired effect is not always achieved and this mainly has to do with the relationship people have with money.
Building a relationship with money is very important. We cannot afford to utilize something we cannot relate with or else we end up in tricky situations. Let’s look at our relationship with our teachers. If you had a great relationship with your mathematics teacher it is highly likely that you would appreciate maths better than if you had a strenuous relationship with your teacher. This is the same thing with money, if you don’t build a good relationship with money, you will have a challenging time understanding how to use it in a way that it works for you. Like Robert Kiyosaki said in his seminal book Rich Dad, Poor Dad, don’t work for money, let money work for you.
When the Bank Rate is reduced, here are a number of things you can do to maintain a sound relationship with money instead of creating a bad relationship by just continuing to spend or take loans you do not need.
Reduce your loan
Due to the reduction in your loan as a result of a drop in the Bank Rate you can maintain your loan at the same amount it was before in order to pay it off faster. You can also increase the loan instead to pay it off faster.
You can use the difference to invest by buying unit trusts or stocks.
You can place the newly found money in an emergency savings account which can help you buffer against Covid-19 times.
Now that we have a better understanding of what money is. It is important that we do not look at money as a foreign entity. Instead it should be viewed as a friend. A friend to help you grow your wealth and a friend to get you the things you want in life.