People hear and talk about money and use money all the time, but few people understand why money functions the way it does.
This blog post seeks to fix that and answer the big question on everyone’s mind: does the phrase “time is money” have any truth to it?
People have used many different things as money over the ages: shells, gold/silver coins, paper currencies such as the dollar. Despite these different forms of money being very different in composition from one another, they all served a few basic functions that are needed for something to be considered money.
Functions of money
Store of Value
Money must hold its value over time. It wouldn’t be very useful if something we used as money lost half its value one day, then gained half of its lost value back of the course of the day on a regular basis. While money can slowly lose value over time through things such as inflation, it must reliably let a saver today buy things in the future.
Unit of account
Everyone needs to be able to agree what money is worth. If I were to offer you a dollar, you would know exactly how much value that dollar has - $1. If you took that dollar and offered it to your neighbor, they would also know exactly how much that is worth to them - $1. A unit of account ensures every knows the price and value of money so that people can agree on prices to sell goods.
Medium of exchange
Money needs to be useful to buy things with. Giant boulders will never be money because no one could lug an entire boulder in their purse and then chisel off a small chunk of it to buy a candy bar. It would be completely impractical! Metal coins and paper currency can easily fit in a pocket and be given to multiple people over the course of a day.
FAQs
Q: I’ve heard the U.S. dollar isn’t “real money” because it’s not backed by anything is this true?
A: What this question is getting at is understanding the two types of money.
- Commodity Money – Money backed by a commodity or good that has intrinsic, inherent value. The most common example of this is gold.
- Fiat Money – Money that is not backed by a commodity or has no intrinsic value such as paper money today.
It is true that the US dollar a fiat currency isn’t backed by gold or silver like it was in at some points in the 1900s. However, that doesn’t mean that it’s worthless. The dollar is backed by the faith people have in that US government and the dollar itself will both continue to exist and be used into the future. While this can take a bit to wrap your head around, and some might wonder why we would leave the gold standard, that is a longer discussion for a future blog post.
Q: Are cryptocurrencies money?
A: It depends! In theory, there’s no reason why a digital currency couldn’t be money and in all likelihood with the world becoming more digital there probably will be widely accepted cryptocurrencies in the future. However, none of the major cryptocurrencies at the time of writing this seem to fulfill that. Take bitcoin for example, and ask yourself how well does it work as a store of value?
As you can see in the graph, the price has wildly fluctuated over the course of a year (up 107% overall, but some weeks will crash more than 20% of its value) which makes it risky as a store of value.
Q: Are credit cards/checks/stocks money?
A: Let’s approach these one-by-one:
- Credit cards – No. Credit cards let you use your money later, but they themselves are not money.
- Checks – No. Checks are a way to access money in your checking account (aka demand deposits). But checks are just a tool like credit cards are to use money.
- Stocks – No. Like bitcoin, stocks are not a good store of value since they frequently go up or down in a moment’s notice.
Q: Is time money?
A: Sadly no. While it functions as a unit of account since everyone agrees one what a minute is, time neither stores value nor can be used as a medium of exchange. It’s still a good saying though since you can use money to “buy back” extra time by paying other people to do your chores.
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