TNT:

Tishwash:  What is money and why do we need it?

 In this article, we review a topic that was most important, but it did not receive the attention it deserves because people take it as if it were an obvious thing. We will talk about the meaning of money, its role in the economy, and what are its uses, among other topics.

 Can the economy run without money?

There are historical examples of economies in which people exchanged goods and commodities in exchange for goods and other goods. In Iraq, for example, when the Bedouins came to the cities, they would exchange their products of carpets, wool and other products in exchange for urban products such as tobacco, sugar, rice and others. But modern economies use cash to carry out trade. 

Money is defined as any asset that people own and accept by others in exchange for the goods and commodities that they sell or use for financial exchanges. An asset here is everything of value owned by a person or company.

Barter system and the invention of money:

For a better understanding of the importance of money, let us look at the case of an economy that does not use money. The economies in which goods and commodities are exchanged for goods and other commodities are called barter economies. 

These economies have major fundamental shortcomings. The exchange of goods and commodities in these economies needs to have a bilateral reciprocal desire. That is, meaning that you need what the other person has, and at the same time the other person needs what you have. It may take a long time and a lot of effort on the part of people for this mutual desire to materialize. 

This renders the barter system an inefficient system and limits commercial exchanges and thus reduces the size of the economy significantly. Therefore, it is not surprising that the peoples who use this system live in deplorable economic situation.

 In order to get rid of the problems associated with the barter system, societies have incentives to create a commodity that most people will accept in exchange for the goods and goods they exchange. For example, Iraqis used gold and silver as a means of exchanging goods and commodities before the concept of modern money developed. Historically, when a certain commodity began to be widely accepted as money, people would start accepting it even if they had no other use for it.

 Selling and buying goods and commodities becomes much easier when the cash is available. People only need to sell what they have for cash and use that money to buy what they want. When cash is available, families are more likely to specialize in producing specific things rather than producing everything they need.  

In modern economies people are highly specialized. They only produce one thing, such as being a doctor, teacher, or accountant, and they use the money they get from their work to buy everything they need. People become more efficient in production when they specialize because they will gain comparative advantage in production.

The high incomes that people achieve in modern economies derive from the specialization in production made possible by the presence of money. Therefore, the answer to the question of why we need money, is that it makes commercial exchange easy and gives people an opportunity to specialize and become more productive and achieve higher incomes.

Functions of money:

Anything that is used as money, for example gold, salt in North Africa, cigarettes in prisons, dinars or dollars must perform four functions:

Exchange broker:

Money serves the function of a medium of exchange when the sellers are ready to accept it in exchange for the goods and commodities they sell. When a food store accepts a banknote in exchange for some bread and milk, that paper acts as an exchange. Through the medium of exchange, people can sell goods and commodities for cash and use the cash to buy what they want. The economy becomes more efficient when people accept a single commodity as the medium of exchange for goods and commodities.

Measuring unit:

In a barter system, each commodity has a very large number of prices. Maybe the price of a cow is fifty chickens, or 200 eggs, or 2 tons of wheat or other things. When one commodity is used as money, each commodity will have one price instead of multiple prices. This function of money gives buyers and sellers a unit of measurement, that is, a means of measuring the value of a good in the economy using money. And because the Iraqi economy uses dinars as money, all goods and commodities have a fixed price in dinars. 

Stock value:

Money allows people to store the value of their money with the money itself. That is, if you did not spend all of your money to buy goods and commodities, you could keep part of the money with you for future use. It is not just money that can be a store of value. Any asset of value, such as a plot of land, a painting, or a piece of carpet, for example can be a store of value. Financial assets, such as stocks and bonds, have an important benefit compared to keeping cash as store value because they yield higher interest or may increase in value in the future. You also have other assets over money for this job because it provides some services: for example, your house provides you with housing service. So why do people keep some cash with them? The answer is simply liquidity, that is, the ease of transferring assets to an exchange broker. Because money acts as a direct medium of exchange, it is the most liquid asset. If you want to buy something and need to sell an asset you own in order to do so, it is very likely that it will cost you some costs. 

For example, if you want to buy a house and you want to sell gold items owned by the family, you may have to sell them at a lower price now. To avoid such costs, people are prepared to keep a portion of their wealth in the form of cash. There are at least two problems with using cash as a store of value. The first is that money loses some of its value over time due to inflation. Second, there is a physical risk like fire, theft, or maybe mice.

Deferred Payment Standard:

Money is useful because it provides a standard for deferred payments in borrowing and lending matters. It can facilitate exchanges at a given moment in time by providing exchange broker function and unit of measure. But it can also facilitate exchanges over time by providing a valuable stockpile function and standard deferred payments. For example, you could buy a car today and pay deferred installments over a period of time with cash.

How important is it for money to act as a store of value and a reliable deferred payment standard?

People care about what their dinars can buy in terms of food, clothing, commodities, and other goods. In other words, the value of money depends on its purchasing power, that is, its ability to purchase goods and commodities. Inflation causes a decrease in the purchasing power of money because higher prices make the same amount of money able to buy fewer goods and commodities. When inflation reaches very high levels, the money becomes a store of value and an unreliable deferred payment standard.

What can be used as money?

When something can be used as a medium of exchange that makes commercial exchanges easier, the economy can operate more efficiently. So the question is, what are the assets that can be used as a medium of exchange? And as we indicated earlier that for anything to be used as money it must be, at least, generally accepted as a method of financial payments. But in practice there are other requirements.

There are five criteria for any asset to be used as a broker:

The original has to be accepted by the majority of people.

It should be of modular quality, that is, every two units of it are identical. Hence, the use of precious metals as money becomes a difficult process due to concerns about the different purity of different metal pieces.

It should continue to exist for a long time so that it does not lose its value as a result of continuous use.

It should be of comparable value to its weight so that large quantities of it can be transported easily in order to be useful for commercial use.

It should be divisible so that people can use it to buy goods and commodities of less than its value and receive the remainder at a value less than the asset itself. (Unless you're a cowboy hero like John Wayne or Clint Eastwood who walk into the bar and shoot, drink, eat, pay and don't take the rest.)

The Iraqi Dinar has these characteristics. 

What makes the Iraqi dinar acceptable as a medium of exchange? Simply put, it stems from personal expectations. You regard an asset as money if you believe that others will accept it in exchange for goods and commodities they give you. Society's acceptance of the use of dinars as money is what makes it acceptable as a medium of exchange.

From here emerges the need to differentiate between the different types of money. We focus here on two types of money.

Commodity money:

They are assets that have intrinsic value separate from their use as money. For example, gold has value in the manufacture of jewelry, dental fillings, and most importantly in the manufacture of microelectronics. But using gold as money is a big problem. The money supply will face great difficulties for the government to control because it depends on the quantities of gold present or that are being discovered.

Paper money (including coins):

The economy would be inefficient if it relied on gold as money. Transporting quantities of gold for use as a medium of exchange for commercial transactions would be difficult, dangerous and costly. In order to avoid this, people in Britain began and by the year 1500 to store gold with goldsmiths and goldsmiths began to issue papers proving the holder's ownership of a certain amount of gold. People took to exchange these papers to meet their needs from purchases. 

Governments and companies in Europe took notice and began issuing documents that could be bought back for gold. As long as people had confidence that the gold backing up those securities was there and available when they asked for it, those documents remained in circulation as an exchange medium. As a matter of fact, paper money was invented.

In modern economies, paper money is issued by the central bank of the state which is one of the state institutions responsible for regulating money supply. The Central Bank of Iraq was established in 1947 by royal will and was previously called the National Bank of Iraq until 1956. At present, there is no country in the world that issues paper money covered with a gold cap. 

Paper money has no value except that it is used as money and therefore it is not commodity money. Paper money is a currency issued by the monetary authority with a decision to consider paper as a currency only.

If you look at the Iraqi dinar, you will see some words that say "a banknote issued by law," meaning that the Central Bank officially issued the note to be used as money. The Central Bank of Iraq is not required to exchange the dinar for gold if the holder of the dinars so desires. The banknotes issued by the central bank are a legal document in Iraq, meaning that the Iraqi government imposes its acceptance by people and companies in their dealings and the payment of government fees. 

Although it is a legal document, it will not be of much use to use as a medium of exchange and it will not work as money if people stop accepting it in general. The key to accepting cash is that families and companies have confidence that if they accept these papers in exchange for the goods and services they sell, they will not lose their value while they hold it before using it again. Without this trust, the banknotes will not function as an exchange.

* Professor of Economics and Political Science, Kansas State University, USA.   link