Money, Banking, and International Finance- Valuable relative to its weight: People can easily carry large amounts of money around
conveniently and use it in transactions. - Divisible: Public can break money down into smaller units to purchase inexpensive goods
and services.
All modern countries use coins and paper bills as money, which possess the five desirable
properties. Total value of paper bills and coins equals currency. Furthermore, people become
psychologically dependent on a currency because they use a particular currency for a long time.
For example, U.S. citizens have used dollars as their currency for two centuries. If the U.S.
government wanted to introduce a new currency with a different name, then the public could
reject the new currency.
Forms of Money
People since the dawn of civilization created payment systems. Thus, money facilitates
business transactions, and the payment system becomes the mechanism to settle transactions.
First and oldest payment system is commodity money. Commodity money is government selects
one commodity from society to become money, such as gold or silver. If society did not use
gold or silver as money, then people still use the commodity for other purposes. People use gold
in jewelry, teeth fillings, electrical wires, or the pins of a microprocessor. Commodity money
could be anything. For example, prisoners use cigarettes as money in U.S. prisons, while people
accepted vodka and bullets as payment in remote parts of Russia during the 1990s.
Commodity money could be full-bodied money. Its value as a good in non-money purposes
equals its value as a medium of exchange. For instance, if the market value of one ounce of gold
is $1,000, and the government made one-ounce gold coins, then the face value of the coin would
equal $1,000. Thus, this coin represents full-bodied commodity money because the coin's
inherent value equals the coin's market value.
Governments discovered a trick about commodity money. What would happen if a
government made one-ounce gold coins with a face value equaled to $2,000 while the coin
contained $1,000 of gold? Subsequently, a government had created $1,000 out of thin air!
Government can create value by “printing money,” which we call seigniorage, and government
could receive significant revenue by creating money.
Government can debase its currency by relying on seigniorage. For example, the Roman
government “printed money” by recalling its gold and silver coins. This it re-minted more coins
that contained less gold and silver by adding cheap metals. In the beginning of the ancient
Roman Empire, coins were almost pure gold and silver, while, towards the end of the empire,
Roman coins contained specks of gold and silver. For example, government can debase coins. If
government issued one-ounce, gold coins for $1,000, and the coins were 98% pure gold, then
government can print money by collecting the old coins and mint two new coins with a value of
$1,000 that only contain 49% gold. Then government fills the remaining 51% of the coin with
cheap metals. Unfortunately, government could create extremely high inflation rates if it
depends on seigniorage too much.