MONEY

Senathon Ipia 
+234 7052802574 | senaipia@gmail.com

Definition of money:

Money is anything that is generally accepted as a medium of exchange and settlement of debts. 

Characteristics or Qualities of Money

(i)         General acceptability:

What is used as money must be accepted as such by all. This is the first and most important characteristic of money. To achieve general acceptability, government always makes it a law that the country’s currency – bank notes and coins – are accepted as a means of payments. So, a country’s bank notes and coins are referred to as legal tender, since they are law-backed.

(ii)        Absolute homogeneity:

Currency notes or coins of a particular denomination must be alike in all aspect. For example, all ₦500 notes are identical.  

(iii)       Portability:

 Money should be easy to carry about.

Lack of portability was why paper money was used to replace commodity money. When gold or silver was used as money, it was lack of portability that made the govt print paper money (currency) to represent the value of the gold or silver. Printing value on paper to represent the value of gold or silver was referred to as gold or silver standard. (This is explained later).   

(iv)       Durability:

Anything used as money should last and not be perishable. 

(v)        Relatively scarce:

Money should be scarce but no too scarce. If money is abundant then it loses it value and there would be inflation because too much money will pursue few goods and services.    

(vi)       Stability: 

The value of money should not change too frequently.

It is inflation that changes the value of money negatively. That is why governments fight inflation so as to maintain the price stability and by extension maintain value of money stability.  

(vii)      No intrinsic value:

Anything used as money should not have value in itself as opposed to its value as a medium of exchange. Example, pumpkin leaf has intrinsic value as vegetable and it is consumed as food, so it cannot be used as money. Precious metals like gold and silver have intrinsic value because they are used as jewelries or ornaments.

Note: Inherent value is a synonym for intrinsic value.  

(viii)     Controllable Supply:

Money should be something whose supply can be controlled. The government controls money supply through the Central Bank – its monetary authority.  

Denominations of Nigerian currency –  the Naira 

Demand for Money (Fiat Money)

This refers to holding money in cash. Money in cash is referred to as liquidity.

Motive (Reason) for Holding Money

1.         Transaction Motive:

Transaction means exchange of goods and services. That is, buying and selling goods and services.
Money is used to settle payment for goods and services.

2.         Precautionary motive:

This is when we hold money to pay for unexpected expenditure or unforeseen circumstances.

3.         Speculative Motive:

This is when we hold money so that when opportunity to make more money comes we can invest to make the money.

Supply of Money (Fiat Money)

Money supply is the total amount of money available for use in an economy.

Types of Money Supply

Types of money supply is defined in terms of how easily and quickly it can be converted to cash. Nigeria’s monetary authority defines money supply in terms of: narrow money (M1) and broad money (M2).

Narrow money (M1): This is currency in circulation plus demand deposit. This means cash-in-hand plus cash-at-bank that account holders can withdraw at any time without prior notice given to the bank.

Broad money (M2): This is narrow money plus savings and time deposits and foreign currency deposits. This means broad money equals narrow money plus bank deposits that last for certain time before it can be withdrawn and foreign currency, which of course is not legal tender in Nigeria, and is therefore not required for day-to-day transactions in Nigeria.      

Functions of Money 

(i)  A Medium of Exchange: goods/services are exchanged for money

(ii)  Measure of Value: The value of goods/services are expressed in terms of money.

(iii) Standard of Deferred Payment:

Money is used to make future payments. This function of money allows goods/services to be 
purchased on credit.  For this function of money to be very effective, the value of money must be 
stable. For instance, if you sell ₦200,000 worth of goods on credit, and payment is deferred until 
months’ time, it should still be worth the same amount, and not lesser value, say, ₦120,000 
because of  inflation or devaluation of the currency by the government.

However, inflation or currency devaluation by the govt does occur, making the value of money to 
decline. The decline in the value of money, owing to inflation especially, is referred to as time value
of money. 

Hint: Time value of money: a fall in the value of money over a period of time.

   

(iv) Store of Value:

Wealth or the value of what someone has can be stored in terms of money. The ‘greatest enemy’ 
to this function of money is inflation and currency devaluation by the govt.   

(v)  Unit of Account: Accounting is done in terms of money.      

Barter System or Barter Economy

Barter system or economy is the exchange of goods/services for other goods/services without the use of money as medium of exchange.

Problems of Barter System

(i)  Problem of Double coincidence of wants:

For exchange to take place under barter, I must have the goods/services that you want and are willing to exchange and you must have the goods/services I want and am willing to exchange.   

(ii)  Problem of Determining exchange rate or value among goods:

How many tubers of yam should be exchanged for a house? Determining this is difficult in barter system.

(iii)  Problem of indivisibility:

Someone needs a book and has cattle to exchange. Certainly, the value of cattle is far more than a book. So, how does he divide the cattle for a book?

(iv)  Problem of saving commodities for future use:

A producer of perishable goods would not be able to keep the goods until when there will be coincidence of wants with another person.

(v)  Problem of buying on credit and borrowing: With money, payment can be deferred and debt settled at a future date. But with barter this is a problem. 

(vi)  Lack of specialization and division of labour: The problem of double coincidence of wants associated with barter discourages specialization and division of labour. To over this problem everybody attempts to produce as many different goods as possible  

History of Money: From Barter to Currency Notes and Coins

It is pertinent to know that it is the need to solve the problem of exchange and payment associated barter system that gave arise to the evolution of money – from barter to commodity money to paper money (banknotes).

The Barter System

The first system of exchange was the barter system, where goods were exchanged for goods. The basic problem of the barter system was the problem of double coincidence of wants. This means that for exchange to take place, this coincidence must occur – you must meet someone who has what you want and at the same time needs what you have for exchange. It may take very long time for this coincidence to occur, and so your search continues. What then is the solution to this problem?

The Use of Commodity as Money   

To solve the problem of double coincidence of wants associated with barter; some commodities were agreed on and generally accepted in exchange for goods/services by different people in different places. This marked the birth of the use of commodities such as salt, cowrie shells, tea as money.

But commodities such as salt, cowrie shells, tea, etc are perishable. Materials used as money should have the quality of durability. To solve the problem of perishability, metallic materials were introduced and used as money. Metals used as money included gold, silver, copper, etc. These precious metals are commodities, too. So, if used as money they are said to be commodity money as well.

In some nations, gold or silver or both were used as money. The Bible records in the book of Genesis that Joseph was sold for 30 pieces of silver. This depicted the use of silver as a means of exchange – money. In the book of Acts of the Apostles, Peter said “gold and silver have I not…”, meaning I have no money on me. So here, both gold and silver were used as money.

The use of these metals led to what was referred to as gold standard or silver standard. Gold standard was applicable to the United States of America, while silver standard was applicable to European nations, including the United Kingdom.            

  

The Gold or Silver Standard: Value of Paper Money Tied to Gold or Silver   

Gold is considered to be a valuable precious metal (commodity), so many nations used gold as their money. But bars of gold are heavy to carry about. One quality of money is portability, that is, should be easily carried about. Also, there was the problem of safety when carrying gold about as money.

How can this problem be solved?

Secured places (banks) to save (store) the gold were created. When someone saves his/her gold with the bank, a paper (written evidence) that showed the amount of gold you have saved with the bank was issued. With the paper issued to you by the bank, you can make payment – the paper represented the gold you have saved (stored) with the bank – you have money in the bank. The store of gold in the bank was referred to as gold reserve.

It was the gold standard in one country but silver standard in another country. So, during the gold or silver standard, government printed paper money, but tied its value to gold or silver. The United States government, for example, printed its currency notes, the dollar, but tied its value to gold. It fixed $20 as equal to 1 ounce of gold. So, the amount of the dollar currency in circulation at that time was equivalent to the amount of gold reserve. If gold reserve increases, the government would print more money.

Tying the value of the US dollars to gold was referred to as the Gold Standard. In the United Kingdom, it was the Silver Standard, as the value of the pound sterling was tied to silver.

In summary, gold or silver standard was commodity money with paper currency representing it. The paper currency that represents the value of the gold or silver was used in exchange for goods/services. The paper currency could as well be exchanged for the gold or silver itself, since it had equivalent value.

Why the Gold/Silver Standard Was Abolished 

The gold or silver standard limited the ability of government to print more money. Usually, if the amount of goods/services increases in an economy, the government would print more money to facilitate exchange for increased volume of goods and services. But under the gold/silver standard, government can only print more money if the supply of gold or silver increases, but the supply of gold or silver was depleting

(Remember: gold and silver are non-renewable resources – a country’s supply of gold or silver could be exhausted).  

In order for the government to print more money to meet the increase in production of goods or services and also to pay its debts, the government abolished the gold or silver standard. The value of money became what was written on the face of the currency, as ordered by the government. This is what is referred to as legal tender/fiat money/token money. (See explanation of these terms below).

Below is a diagram showing stages in the history of money:

Stage 1: Barter system (exchange of goods for goods)

Stage 2: Commodity money (using some commodities as money)

Stage 3: Gold/Silver standard: value of paper currency tied to gold/silver (representative money)

Stage 4: Paper and coin currency as legal tender (fiat money)

 

Our Currency as Legal Tender/Fiat Money/Token Money                            

The terms legal tender, fiat money and token money all refer to our currency notes and coins.

Legal Tender

The word ‘legal’ is the adjectival form of the noun ‘law’. So legal tender is used to mean money backed up by law.

Let me explain: Currency notes are mere printed papers, but we accept it in exchange for our goods/services because the law commands us to. The Nigerian naira (NGN), the United States dollar (USD), the British pounds (GBP) are legal tender.

In our today’s world, the face value (nominal value) of money depends primarily on government degree that it is legal tender. But the real value of money is determined by price level.   

Legal tender means that there is a force of law binding anybody to accept that ‘paper’ as a means of payment.   

Fiat Money

Fiat money is another way of looking at currency notes and coins. Fiat money is used to refer to money with no intrinsic (inherent) value but backed by government order. The word ‘fiat’ means govt order. So, the fiat money is NOT commodity money, but paper that the govt printed and ordered that it should be accepted as money.

Let me explain: Our ₦1000 note, for example, is a mere paper. It has no value except that the govt order that it should have a value of one thousand naira. So, the value of ₦1000 attached to it came from govt order. The Nigerian Naira (NGN), the United States dollar (USD), the British pounds (GBP) are examples of fiat money. 

Token Money

It costs something to print currency notes or mint currency coins. Usually, the value written on the face of the money is more than the value of the material used to print or mint it. So, token money is money whose face value is higher than its intrinsic value or inherent value.

Consider that if the face value of money is not higher than its intrinsic value, people would use it for something else. If ₦20, for example, were imprinted on a gold coin and used as money, who would spend it after it gets into his or her hands?  The Nigerian naira (NGN), the United States dollar (USD), the British pounds (GBP) are examples of token money.

Summary of how to differentiate Legal Tender, Fiat Money & Token Money

- Legal tender is money backed up by law

- Fiat money is money that is NOT commodity money or backed by commodity.

- Token money is money whose face value is higher than its inherent or intrinsic value (value of the material used to make it.)

Types of Money

1. Commodity money: Commodity used as money to exchange for goods and services.  

2. Representative money: Something used to represent money and not money itself.

3. Fiat money: currency notes and coins, as backed by govt order.

4. Electronic money: This is cashless payment or transfer of money that is represented by cash.

We accept electronic money because it represents cash. For example, if money is transferred to your account electronically, you can walk to the ATM or bank cashier to cash it.

Electronic money include:

(a)  mobile money transfer, where an individual account holder would transfer from his/her bank a/c to another person’s bank a/c as payment for goods/services.

(b)  bank electronic fund transfer, where a corporate organization would authorize its bank to transfer money from its a/c with the bank to a certain beneficiary’s a/c.

(c)  use of point of sale (POS) machine to pay for goods/services purchased by inserting your ATM card  (debit card) to the POS machine, and entering the amount. The bank a/c of the person paying is debited with the amount and the bank a/c of the receiver (seller) is credited with the amount.     

Value of Money

The face value of money (also referred to as nominal value) is determined by the government (as legal tender). But the real value of money is determined by its purchasing power. The real value of money means the amount of goods and services that money can buy at a particular time. So, price level determines the real value of money. There is therefore inverse relationship between the value of money and price level; as price level goes up, the value of money falls, and as price level goes down, the value of money rises.

Now when we say value of money in our day-to-day conversation we mean ‘real value of money’ NOT face value of money. $1,000 note and ₦1,000 note have the same face value, but are they equal in value? Certainly not!  We simply use value of money to mean real value of money.          

Measuring the Value of Money

If price level determines value of money, then we need to measure the percentage change in price; that is Price Index. Changes in price level depict inflation or deflation. So, to measure the value of money, we measure inflation or deflation in the economy, using the consumer price index. (See the topic: Inflation & Deflation).

Note: Consumer price index is a better price index measure of inflation & deflation than producer price index.       

Seigniorage: Profit from Printing or Minting Money 

Do you know that it costs money to print or mint money? Think of the materials used, including ink. Are they not purchased? Surely, they are! But in printing or minting money, the face value of each currency note or coin is made higher than the cost of printing or minting it. For example, if the unit cost of a currency note is ₦120, then it must be given a face value higher than ₦120, otherwise printing the money would be of no use. So, usually, the face value of a currency note (money) is higher than its production cost. This profit is termed seigniorage. 

Seigniorage is therefore the difference between the face value of a currency and the cost of producing it.   

Other Terms

Near Money

This refers to assets or financial instruments that can be easily converted to cash. Examples are cheques, bank draft, certificate of deposit, money market instruments, etc. The accountant refers to near money as cash equivalent.

Fiduciary Issue

An issue of bank notes NOT backed by gold but by govt securities.

Gresham’s law in Economics: Bad money drives good money out of circulation  

Velocity of Money

This refers to the number of times money changes hands in the economy. Or the rate at which
money is spent in the economy.  

Velocity of money = nominal GDP

                              money supply

For the purpose of simplicity, let us illustrate with a two person economy – Sena and Yemi. And we also assume that money supply in the economy is ₦10,000. If in the month of January, Sena bought goods worth ₦10,000 from Yemi.  Yemi in turn bought some other goods from Sena for ₦10,000 in the same month. In this first month of the year the “GDP” of the economy would be ₦20,000.

Assume that in all the transactions, they spend all the money buying from each other, and that the transactions occur 12 times in the year; then the annual GDP would be ₦240,000. Remember that the money supply is still ₦10,000.

So, velocity of money = nominal GDP     =    ₦240,000     =   24

                                                  Money supply                ₦10,000

Cryptocurrency

We discuss cryptocurrency from economics point of view not technical point of view.

Cryptocurrency is digital currency. It is virtual currency, meaning it is not physical, as it only exists in the computer. Examples of cryptocurrency are bitcoin, and its alternatives, often referred to as altcoin, which include litecoin, ethereum, etc.

The process of producing cryptocurrency is termed “mining”. To mine cryptocurrency some powerful computers are required.

The first cryptocurrency is bitcoin. It began (was invented) in 2009. It is said that the maximum number of bitcoin that can be mined is 21 million. Perhaps, this is why its alternatives had been introduced. 

In the computer, cryptocurrency transactions are recorded in digital ledger, known as blockchain.

Unlike fiat currency whose production is centralized and supply regulated by a country’s monetary authority, the central bank, cryptocurrency is decentralized and unregulated. A country’s central bank controls the production and issue of its currency notes and coins. The banks, which are regulated by the central bank, are involved in the issue and payments of the fiat currency. This and more is what we mean by centralization and regulation.

But for cryptocurrency, it is not the central bank that produces it – nobody is the sole producer of cryptocurrency – anybody willing can mine cryptocurrency. This is what is meant by decentralization.  Payment of cryptocurrency is unregulated by central bank.   

Note: Govt can come up with relation at any point in time. There is a country that intents to create its own cryptocurrency. This means that bitcoin and its altcoin may have no place afterwards in the country.  

Transaction Motive of Holding Cryptocurrency

Cryptocurrency has no intrinsic value and is no legal tender, so what is giving it value? The value is its use for payment! Since cryptocurrency is not a legal tender, there is no force of law binding anybody to accept it as a means of payment – it is only optional to the person willing to accept it.

But some people accept cryptocurrency, especially bitcoin as means of payment. So the value for bitcoin arises from the HIGH DEMAND for it to pay for transactions. Remember, anything with high demand must appreciate in value. In economics, we say the higher the demand the higher the price.

The value of each bitcoin or other crytocurrency is measured in terms of fiat money i.e. paper currency such as the US dollars (USD), British Pound (GBP), the Euro, etc. For example,          

Speculative Motive of Holding Cryptocurrency

Just like profit can be made from trading soft currencies with hard currencies, profit can be made from trading cryptocurrency.  For example, in May 2015, the exchange rate was about ₦200 to 1$. But in May 2017 it was about ₦305 to 1$. So, a Nigerian businessman who bought $10,000 in May 2015 and held it until May 2017 would gain ₦1,050,000 by selling it in May 2017 (i.e. ₦3,050,000 – ₦2,000,000 = ₦1,050,000).   

For cryptocurrency, one bitcoin was worth about $1,129.87 as of January 4, 2017 but about $14,584.56 on January 4, 2018. This was huge profit for those that held bitcoin for speculative (trading) purpose.         

Some proponents of cryptocurrency keep persuading people to buy cryptocurrency – that it would appreciate in value. The demand for cryptocurrency is what gives it the value, hence the persuasion by these people.  Buying and selling cryptocurrency is exchanging fiat currency with cryptocurrency. 

Note: Currencies having stable exchange rate over a longer period like US dollar, British pound sterling, Euro, Japanese yen are called hard currencies, while currencies whose exchange rate fluctuates from time to time are called soft currencies.

Can Cryptocurrency be Used as a Store of Value?

Our fiat currency can be used as a store of value because of its legal backing as a legal tender. There is an assurance that the paper money you store would always have value. Even if govt would change the paper notes it would not do so without redeeming the paper notes it had earlier issued with the new notes.

But for cryptocurrency, uncertainty surrounds its use as a store of value, especially in the very long term, if it remains unregulated. However, in the short term, it could be used as a store of value.  

Can Cryptocurrency Serve as an Investment?

Fiat currency (fiat money) is not an investment but a means to getting investments. Cryptocurrency is seen as “property” not as currency in some countries. So if cryptocurrency is sold and profit is gained, capital gain tax is chargeable. In taxation, capital gain tax is the difference between market value and book value of a property.

In some countries, cryptocurrency exchange exists – where buying and selling of cryptocurrency take place. This is somewhat like stock exchange, for buying and selling of company shares. If buying of shares in the stock exchange is investment, so does buying of cryptocurrency in the cryptocurrency exchange mean investment.

But we buy a company’s shares in the stock exchange because the company is creating an underlying economic value in form of profit from production of goods and services – and dividend is our reward if we keep holding our investment in shares, and capital gain (capital appreciation) if we sell the investment. Dividend is payment to us the investors out of the profit made by the company, and capital gain is gain in fiat money upon selling the investment. 

But for people who buy cryptocurrency, they only get capital gain upon sale of the investment.