Money and Banking - Exploring the Role of Money in America

What is Money?

What do the following items have in common? Bronze knives, farm tools, cacao beans, salt chunks, stone disks, fish hooks, beaver pelts, musket balls, nails and cigarettes. Well the answer is that all of these items have been used as money! Money you say oh wise one? Yes, money. Not money in the sense that you know it today but yes, money.

Lets think about what money really is:

Money: Anything accepted as payment for goods and services by most people in an area at a given time.

Think about it, if most of the people in a region are willing to accept a certain item as payment for goods and services then that item has a use as money. It is sort of like the way cigarettes are portrayed as money in the movies. Now the reality is that these types of money, informal money that has another basic use if you will, are not money as you normally have thought of it. This type of money is called commodity money. The origins of money can be traced back to ancient times. Then commodity money, money that has an alternative use, was used. In the South Pacific and Africa, cowrie shells were the common forms of currency while in New Guinea, it was dog teeth that were used. At Santa Cruz, the feathers of hundreds of honey-eating birds were attached to short sticks to make feather-stick money while in the Marshall Islands, fishhooks were commonly used. In ancient China tea leaves were compressed into “bricks” while the Russians used compressed cheese as their currency. Commodity money was still present during the colonial age when many products such as gunpowder, musket balls, corn, and hemp were commonly used.

In 1618 tobacco became the most famous type of colonial money because the governor of colonial Virginia gave it a monetary value of three English shillings per pound. However, fiat money, money by government decree, has come to replace commodity money. In 1645 Connecticut established a monetary value for wampum, a form of currency that the Narragansett made out of white conch and black mussel shells. Because the Narragansett and the settlers used wampum in trade, certain shells were made equal to 1 English penny. In the 1700’s the Governor of the then territory of Tennessee was paid a salary of 1000 deerskins a year! His secretary of state was paid 500 raccoon skins. Quite a salary huh!

As time progressed, other forms of money were used. In some states, laws were passed allowing citizens to print their own paper currency. Backed by gold and silver deposits in banks, it served as currency for the immediate area. Some states passed tax-anticipation notes that could be redeemed at the end of the year. The governments printed the notes, which were used to pay salaries, buy supplies, and meet other expenditures until taxes were received and the notes redeemed. The taxes though, were collected in coins.

Paper money was really first seen around the time of the Revolution. In 1775 the Continental Congress authorized the printing of Continental Currency which had no gold or silver backing. By the end of the war nearly $250 million had been printed and spent.

Money as you know it today is not commodity money. Today most money is what we call fiat money. Fiat money is money by government decree. Wampum was the first fiat money used in the America’s. It had a set value, equal to a certain amount of gold, established by Connecticut in 1645. Since the government of Connecticut established it as official money it is fiat money.

The concept of paper currency was not well regarded early on. Most Americans, indeed most people world wide, felt that paper currency was risky since it had no inherent value. As a result most fiat money was in the form of coins. This coined money is known as specie. Specie was well regarded because it some metallic content, either gold or silver. Due to scarcity this then had some inherent value of its own. In fact paper currency was not even issued until 1775 when the Continental Congress printed a very small amount of paper currency to pay its debts.

So, why do we use money at all? Well the reality is that the use of money is very much tied to the Industrial Revolution. As the world grew increasingly modern money became needed. Before money was used the world was primarily agricultural. People living in traditional economies used barter as a means of exchanging goods and services. Barter presented great difficulty in completing transactions and in fixing value. With the Crusades and the corresponding growth of towns and villages and increased trade money became a necessity. Industrialization would have been impossible without money.


Money serves, therefore, three essential functions:

  • It is a Medium of Exchange – money is used so we can exchange goods and services easily. In barter this is very difficult because transfer of large items and perishable goods makes moving around a little tough.
  • It is a Measure of Value – money is used so we can assess fairly and consistently the comparative worth of items. In barter this could not occur because it is impossible to compare the value of different commodities consistently. For example, trading two cows for a goat and a three legged dog. Whose to say what is worth more??
  • It is a Store of Value – money is used so that we can save our earning for a later date In barter this cannot occur because often items might die or rot!

Money also has three essential characteristics.

  • Portability – Money is small and transportable. Imagine using certain types of commodity money. What if Cows where accepted as commodity money. Can you imagine walking around with a cow in your pocket??? A little difficult huh?
  • Divisibility – Money can be broken down into smaller or larger units of measure to make transactions easier. Can you imagine the cow scenario? Its not like you can rip of a leg if the whole cow wasn’t necessary as payment!
  • Durability – Money lasts. Specie lasts forever and even paper currency is pretty durable. In class I ripped a twenty dollar bill in half once and then taped it back together. It was still worth the same wasn’t it? Imagine trying that with a cow! Eventually even an un dismembered cow would die, rot and stink. Not too durable.
  • Stability of Value – Money, despite the influences of inflation and deflation remains fairly stable in value. Money is not subjected to the natural forces of weather as much early commodity was. In traditional economies when one needed goods he would trade crops. If there was a drought, however, the value of said crops would shoot way up. Since most money is in one way shape or form tied to known gold reserves, it is stable in value.

Understanding Money: Its Essence and Economic Function

Money, often symbolizing wealth and power, is an integral component of economic structures worldwide. This essay explores the essence and economic functions of money, offering insights into its development, properties, forms, and future prospects. Understanding money is crucial as it influences economic policies, financial planning, and the global economy’s stability and growth.

Historical Development of Money

Barter System Limitations

Before money, societies engaged in bartering, where goods and services were exchanged directly. However, the barter system was inherently inefficient. The primary issue was the ‘double coincidence of wants’, which meant that two parties had to want what the other offered. This limitation made trading cumbersome and limited economic growth.

Introduction of Commodity Money

Due to the barter system’s inefficiencies, societies adopted commodity money, goods intrinsically valuable and widely accepted as payment. Common examples include gold, silver, and salt. Commodity money alleviated trading constraints, facilitating smoother transactions and providing a value store, albeit still presenting challenges like valuation inconsistency and divisibility problems.

Emergence of Metal Coins

Metal coins emerged as an improved form of commodity money. Created from valuable metals like gold and silver, coins were durable, divisible, and relatively easy to transport. Their uniformity and standardized value promoted wider acceptance, laying a foundation for contemporary monetary systems and enhancing trade efficiency.

Advent of Paper Currency

The introduction of paper currency was a pivotal moment in monetary history, providing a lightweight, portable, and easily transactable medium. Initially, paper notes represented a specific gold or silver amount held in reserve. Over time, the intrinsic value linkage weakened, paving the way for fiat currencies.

Development of Electronic Money and Cryptocurrencies

The digital era ushered in electronic money and cryptocurrencies, revolutionizing transactions and monetary value storage. Electronic money, represented by digital equivalents of paper currency, facilitated online transactions, while cryptocurrencies offered a decentralized, secure, and global trading medium, highlighting the continuous evolution of money throughout history.

The Functions of Money

Medium of Exchange

Money facilitates transactions as a universally accepted medium of exchange, allowing individuals to buy and sell goods and services efficiently. This function of money eliminates the need for a double coincidence of wants, streamlining trade processes and promoting economic activity.

Unit of Account

As a unit of account, money provides a standard measure for pricing goods and services, enabling market participants to compare values effectively. This uniformity simplifies accounting processes, aids in budgeting and financial planning, and fosters a transparent and competitive market environment.

Store of Value

Money serves as a store of value, retaining its worth over time and allowing individuals to save and accumulate wealth. This function ensures that money received today maintains its purchasing power in the future, providing economic agents with financial stability and security.

Standard of Deferred Payment

With money acting as a standard of deferred payment, individuals and businesses can settle debts and obligations over time. This characteristic supports credit and loan systems, which are vital for investment, consumption, and overall economic growth.

The Properties of Money


Money must withstand wear and tear from continuous usage, making durability a crucial property. Durable money maintains its appearance and functionality over time, preserving its value and promoting trust among users.


Portability is vital for facilitating transactions, as money needs to be easily transportable. This characteristic allows individuals to conduct trade conveniently, whether through physical cash, cards, or digital wallets, supporting the fluidity of modern economic activities.


Divisibility ensures that money can be broken down into smaller units to accommodate various transaction sizes. This property allows for precise pricing and flexible payment options, catering to the diverse needs of market participants and facilitating widespread money usage.


Uniformity refers to the consistent appearance and value of money within a specific type or denomination. This property fosters confidence and reduces confusion among users, streamlining transactions and promoting a stable and efficient monetary system.

Limited Supply

Money’s value is significantly influenced by its supply. A limited and well-regulated supply of money preserves its worth and prevents inflationary pressures, ensuring that money remains a reliable store of value

The Different Forms of Money

Commodity Money

Commodity money derives its value from the commodity it represents. This form has intrinsic value, as the materials used, like gold or silver, are valuable. Commodity money’s value is often stable, providing a reliable exchange medium, though it may lack convenience and divisibility.

Representative Money

Representative money does not hold intrinsic value but represents a claim to a commodity. It facilitates exchange without requiring the physical movement of precious metals, serving as a receipt or token that can be exchanged for its commodity value, combining intrinsic and extrinsic value aspects.

Fiat Money

Fiat money is government-issued currency with no intrinsic value, deriving worth from government decree. Its value is subject to economic fluctuations, and it is not backed by physical commodities, relying on public trust and acceptance to function as a legal tender for all debts and transactions.

Electronic Money

Electronic money represents fiat currency in digital form, facilitating online transactions. It is stored on electronic devices or remote servers and enables instant transactions, reducing the need for physical cash and enhancing convenience and efficiency in the modern economy.


Cryptocurrencies are decentralized digital assets using cryptographic techniques for secure transactions. They offer anonymity, lower transaction fees, and global accessibility. However, their value can be highly volatile, and regulatory frameworks are still developing around them.

Money Supply and Monetary Policy

Defining Money Supply

Money supply refers to the total amount of money available within an economy. It includes various components, such as cash, checking accounts, and other liquid assets, playing a pivotal role in influencing inflation rates, interest rates, and the overall economic activity.

Overview of Monetary Policy

Monetary policy involves the manipulation of money supply and interest rates by central banks to control inflation, stabilize currency, and foster economic growth. It is a critical economic tool affecting employment rates, price stability, and long-term economic prosperity.

Instruments of Monetary Policy

Central banks employ various instruments to implement monetary policy. These include open market operations, discount rates, and reserve requirements, each influencing the money supply and interest rates in distinct ways, affecting overall economic activity and financial market dynamics.

Central Banks and Their Role

Central banks oversee monetary policy, ensuring economic stability by controlling inflation and deflation, regulating money supply, and acting as lenders of last resort during financial crises. Their decisions impact financial markets, economic growth, and the financial wellbeing of citizens.

Money and Inflation

Relationship Between Money Supply and Inflation

The money supply within an economy is intrinsically linked to inflation. An excessive money supply can lead to inflation, diminishing money’s purchasing power. It is vital to maintain a balanced money supply to support economic stability and sustainable growth without triggering hyperinflation.


Hyperinflation occurs when inflation rates skyrocket uncontrollably, leading to severe economic instability. It usually results from an excessive money supply without corresponding economic growth, causing money to lose its value rapidly and prices to soar, severely impacting the economy and citizens’ livelihoods.

Deflation and Its Impacts

Deflation, the opposite of inflation, is the reduction of the general price level in an economy. While it increases money’s value, deflation can hinder economic growth by encouraging hoarding money, leading to decreased consumption, investment, and employment, creating a vicious economic cycle.

Inflation Targeting and Central Banks

Inflation targeting is a monetary policy where central banks adjust the money supply to achieve a specified inflation rate. This approach aims to maintain price stability and predictable inflation, supporting economic growth and employment while preserving money’s value.

The Future of Money

Predicting Trends: Digital Currencies and Cryptocurrencies

The future of money is steering towards digitalization, with digital currencies and cryptocurrencies gaining prominence. These innovations offer increased efficiency, lower transaction costs, and enhanced security, though they also present challenges such as regulatory concerns and technological barriers.

The Role of Central Bank Digital Currencies (CBDCs)

CBDCs represent a novel form of money issued by central banks in digital format. They promise to combine the convenience and security of digital forms with the regulated and risk-free environment associated with traditional currencies, potentially playing a significant role in the future monetary landscape.

Challenges and Opportunities

While the future of money is promising, it also poses challenges, including regulatory issues, technological constraints, and concerns related to privacy and security. Addressing these challenges is crucial to harnessing the opportunities offered by the evolving monetary landscape.


The multifaceted concept of money is pivotal to economic structures, facilitating transactions, serving as a value store, and acting as a value measurement unit. Its evolution, from the rudimentary barter system to sophisticated digital currencies, underscores its adaptability and the continuous quest for improved exchange mediums. Understanding money’s properties, functions, and forms is crucial in navigating the intricate economic landscape, making informed financial decisions, and contributing to discussions on monetary policy and financial stability. The future of money, while uncertain, is undoubtedly digital, with innovations like cryptocurrencies and CBDCs heralding a new monetary era, offering both challenges and opportunities for individuals, businesses, and policymakers alike.

Frequently Asked Questions about Understanding Money

Money serves multiple purposes crucial to the functionality and efficiency of an economy. Firstly, it acts as a medium of exchange, facilitating the buying and selling of goods and services by eliminating the need for a coincidence of wants required in barter systems. Secondly, money functions as a unit of account, providing a consistent measure of value. This role helps in comparing the costs of various goods and services, aiding in the valuation and calculation of prices, which is essential for budgeting, accounting, and financial reporting. Thirdly, it serves as a store of value, retaining its value over time. This function allows individuals to postpone consumption until they deem necessary, fostering savings and future investments. Lastly, money is a standard of deferred payment, enabling credit transactions that support economic activity and growth.

The concept of money has undergone significant transformations since its inception. Initially, economies operated on a barter system, where goods and services were exchanged directly. This system’s limitations led to the adoption of commodity money, tangible objects like gold or salt with intrinsic value. With the need for a more practical alternative, metal coins and eventually paper currency were introduced, providing a portable and divisible means of transaction. The 20th century saw the emergence of electronic money, with transactions conducted through credit and debit cards, online platforms, and mobile devices, significantly enhancing transaction speed and convenience. More recently, cryptocurrencies have been introduced, offering a decentralized, secure, and global form of digital currency.

The money supply refers to the total amount of monetary assets available within an economy at a specific time. It plays a pivotal role in determining the rate of inflation, which is the increase in prices and fall in the purchasing value of money. When there is more money circulating in the economy than there are goods and services available, the excess demand leads to price increases, resulting in inflation. Central banks monitor and adjust the money supply to control inflation rates intentionally, maintaining economic stability. Understanding the intricate balance between money supply and inflation is essential for effective monetary policy and economic forecasting.

In the contemporary economic landscape, money exists in various forms. The most traditional form is fiat money, which includes physical cash and coins, issued and regulated by governments, with value backed solely by law and not tied to any physical commodity. Another prevalent form is electronic money, which represents fiat money in digital form, used for online transactions and stored on electronic devices or cards. Cryptocurrencies like Bitcoin and Ethereum, represent a newer, decentralized form of digital money relying on cryptographic techniques for secure, anonymous transactions. Furthermore, representative money still plays a role in some economies, wherein the money itself holds no intrinsic value but represents a claim on a commodity that can be redeemed.

Central banks control the money supply as part of their mandate to maintain economic stability. By adjusting the money supply, they can influence inflation rates, interest rates, and economic growth. When the money supply is increased, interest rates typically fall, encouraging spending and investment, which in turn stimulates economic growth. Conversely, reducing the money supply tends to increase interest rates, discouraging spending and slowing down the economy. This ability to influence macroeconomic variables allows central banks to target low and stable inflation, supporting steady and sustainable economic growth while minimizing unemployment.

Cryptocurrencies diverge significantly from traditional forms of money. Firstly, they are decentralized, meaning no central authority, like a government or financial institution, oversees or regulates their issuance and use. This characteristic offers users more autonomy over their finances. Secondly, transactions made with cryptocurrencies are often anonymous. While transaction histories are public, the identities of the people involved in transactions are encrypted. Thirdly, cryptocurrencies operate on technology called blockchain, a decentralized technology spread across many computers that manage and record transactions. Lastly, they present a level of volatility in their value, which can be risky for users but also provides opportunities for investors.

Several factors determine the value of money. The supply and demand for money significantly influence its value. When there is more money in circulation than what is needed, its value decreases, leading to inflation. Conversely, if the money supply is tight, its value increases. Interest rates, set by central banks, are another crucial factor. Higher interest rates offer lenders a higher return relative to other countries; therefore, higher rates attract foreign capital and cause the exchange rate to rise. Furthermore, government debt, political stability, and economic performance also influence the strength and stability of a country’s currency.

Yes, money’s value can and does change over time, a phenomenon primarily observed through inflation or deflation. Inflation occurs when the prices of goods and services rise, eroding the purchasing power of money. It is often a result of an over-supply of money in the economy or an increase in demand for goods and services. On the other hand, deflation is characterized by falling prices of goods and services, leading to an increase in money’s value. While it might seem beneficial, deflation can lead to reduced consumer spending, as people wait for prices to fall further, leading to economic downturns. Central banks actively work to manage inflation and deflation to ensure a stable economic environment.