In ancient times, man’s wants were but few. He led a simple life and mainly lived on hunting and fishing and satisfied all his wants himself.
As time passed, his wants multiplied and his self-sufficiency disappeared. He began to exchange some of the things he produced for those which neighbours possessed.
Such direct exchanges, without the use of money, are called BARTER. It means buying goods with goods. Today barter is carried on only in un-civilised and backward areas. In modern communities, on the other hand, rarely do we come across exchanges of this type.
Today we cannot think of life without money. It is not imaginable. Our needs are far too many and far too complex to be satisfied through a direct exchange of goods. How shall we pay for the many small things like cakes of soap, vegetables, fruits, pens and paper, etc., which we need every hour of our life? In what form to pay for a bus ride or our college fees? With pots of butter? With a bundle of hay? With a leg of mutton? It would be most inconvenient, may impossible.
Inconveniences of Barter:
Thus we see that barter was very inconvenient. If we had to satisfy all our needs by this method today, life would become a big ordeal. Money in the form of coins, notes and cheques is indispensable for the existence of the modern economic order and for the conduct of our ordinary business of life. A change to a barter economy would, therefore, involve us in too many inconveniences.
We briefly mention some of them below:
Need for Double Coincidence:
When goods have to be directly exchanged for goods, it is essential that both parties should stand in need of each other’s possessions. A shoemaker may need a hat, but what if the hat-maker does not want any shoe? In that case, a lot of time and energy may have to be spent in finding out a person who not only has a hat but is also prepared to part with it for a pair of shoes.
No exchange can take place unless one party precisely wants what the other can spare, and can spare what the other wants. The greater the number of transactions of such type needed by a community, the greater the difficulties to be faced in discovering the double coincidence of wants.
Difficulty of Sub-division:
Barter needs the units of sale and purchase to be adjusted. After the rate of exchange between the two bargaining parties is settled, there is another difficulty to be got over. Suppose ‘X’ has a cow and wants some salt. Obviously he cannot split his cow without losing its value. If, therefore, he is prepared to accept salt for his cow, the quantity will be far greater than he can use immediately. ‘X’ will then have to find a person who needs salt and ho can spare some other goods which ‘X’ can use to satisfy his requirements. The search for such a person involves a great deal of bother and inconvenience.
Absence of Common Measure of Value
Let us suppose that a person has been found who has in possession what ‘X’ needs and is also prepared to part with it. There is still another difficulty calling for a solution. At what rate should the two commodities exchange? Much time and energy will be lost in striking a bargain specially over goods which do not conform to any common measure of value.
Hence, there are no means of comparing their values. Even when after all the bargain is struck, both the bargaining parties will remain dissatisfied. In a money economy, everything is exchanged for money. Money thus becomes a common measure of value and an idea of relative value of things comes to be formed. This helps in the establishment of a rate of exchange. In the barter economy, everything exchanges for everything else every time. There is no common medium of exchange or measure of value. Hence it is difficult to establish a rate of exchange.
No ‘Store of Value’. Goods cannot be stored for a long time. They lose in value. Some of them wholly perish after some time. Think what would happen if each of you brought a little pig, a fowl, a calf or a goat to pay your college fees. The college will have to keep a whole zoo of them. It would be a job to feed the birds and beasts and look after them, and if a plague came, the whole stock would be lost in no time. Such things cannot be stored as money can be.
Evolution of Money:
As barter was an inconvenient method of exchange, people were compelled to select some commodity which was most commonly accepted in that area as a medium of exchange. Thus a large variety of goods came to be used as money: wheat, corn, tobacco, skins, beads, ‘cowries’ shells, gold dust, etc. Even live animals served as a medium of exchange at different times in different parts of the world according as any one of them was generally accepted in exchange for other things.
In the living memory of some of us, ‘cowries’ were commonly used in the villages in India to make small purchases. Money has now taken their place. Even today, however, each country has its own monetary system, and the money of one is not usually acceptable outside its borders. In fact, this is one of the reasons which makes international trade different from internal trade.
Gradually, the most attractive metals, gold and silver, were adopted as money almost everywhere. Rulers in all lands found making coins a profitable business and took it into their own hands. Later, coins were replaced or supplemented by paper notes for reasons of economy and convenience. Still later, cheques, drafts and promissory notes came to be used in addition to notes. Now, bank deposits which are only entries in the bank ledgers serve as the most important type of money. Thus, different stages in the development of money are: commodity money, metallic money, paper currency and, finally, bank money.
Definition of Money:
But what is money? It is anything which is generally accepted in exchange for other things and which can discharge all obligations, past and present. For money general acceptability is essential. Thus currency notes are money, but not cheques. Cheques are not accepted by all. They are accepted only from known persons in India. In the U.S.A. Britain, and other advanced countries, however, even cheques are regarded as money, since they are generally acceptable.
According to the conventional approach, money is defined on the basis only of its function as medium of exchange. When so defined, money includes currency and bank demand deposits since they are generally and immediately acceptable, as medium of exchange. Thus money stock = Cash + Demand Deposits in Banks. This money stock is generally called M’. This concept excludes all other assets (not so liquid) like time deposits, post office savings bank deposits and liabilities of non-banking financial institutions, which are all known as near money.
Then there are economists like Milton Friedman who do not regard money as mere medium of exchange but also as a store of value. Keynes used the term ‘money to hold’. When money is defined as a store of value, it is considered to include other assets besides currency and bank demand deposits like time deposits in banks as well as saving bank deposits. They are called near money.
Functions of Money:
We have seen that different commodities had been selected as money from time to time, and that precious metals like gold and silver, and later paper, ultimately proved to be the best. Best for what? Best for performing the functions of money.
What functions does money perform?
Money performs five very important functions:
(i) It serves as a medium of exchange.
(ii) It is used as a store of value. In more modern terminology, it helps to keep resources liquid.
(iii) It is a standard for measuring values.
(iv) Money serves as a standard for deferred payments.
(v) It transfers value.
Now a word about these functions.
(i) Medium of Exchange:
We have already referred to the various inconveniences arising out of barter. Money solves all the difficulties of barter. There is no necessity for a double coincidence of wants in a money economy. The man with the cow who wants to purchase a horse need not hunt for a horse-seller who wants a cow. He can sell his cow in the market for money and then purchase a horse with the money thus obtained.
The convenience is very great when the person has to sell his services or goods in an unfinished state which no consumer in the narrow sense wants. They can be easily turned into money, the general purchasing power. The difficulty of indivisibility of certain articles is also eliminated. Money units are of all denominations, and it is easy to make fractional purchases, which are not possible under most cases of barter.
(ii) Store of Value:
Money serves as a store of value, or more correctly, it enables a person to keep a portion of his assets liquid. Liquid assets are those which can be used for any purpose at any time one likes. Most persons in the modern world have to keep currency notes in their pockets or at home, or they may keep current accounts with the banks with draw-able by cheque. The necessity arises from the fact that the stream of income and that of expenditure do not keep time with each other. An employer has to pay wages, etc., periodically, even daily, while his income does not come to him in the same periodical intervals. Money is best kept as a store of value.
(iii) Standard Measure of Value:
One inconvenience of barter, as noted, was the lack of a common measure of value in terms of which other values could be expressed and added and accounts kept. Money removes this difficulty too. In a money economy, it is easy to compare the respective values of commodities and services.
They are in proportion to their respective prices. Expression of values in prices enables us to add them up and have a definite idea of a person’s or a community’s wealth. In matters of exchange, a common standard of value makes the transaction easy and also fair.
(iv) Standard of Deferred Payments:
Money also serves as a standard of payments which are to be made after a lapse of time. Lending and borrowing, therefore, must take place in terms of a commodity which will, reasonably speaking, keep its value stable over time. Most commodities deteriorate with the passage of time. But if the money material is properly selected and managed, its value can be kept more stable than that of other articles. By serving as a standard measure of payments over time, money makes borrowing and lending much less risky. Thus, it helps in stimulating all kinds of economic activity which depends on borrowed money or credit.
Functions of money have been summed up in a couplet:
“Money is a matter of functions four, a medium, a measure, a standard, a store.” It should be noted that all these functions of money are not independent of each other. Money is kept as liquid assets, for instance, because it serves as a medium of exchange. It is accepted as a medium of exchange because it has comparative stability of value. For the same reason, it serves as a standard for deferred payments and as a measure of value
Means of Transferring Value:
There is another function which money performs. One can sell one’s immovable and movable belongings at one place and buy them elsewhere. Value will thus be transferred. When does Money Cease to perform its Functions?
The basic function of money is to serve as a stable medium of exchange so that it can serve as a standard of deferred payments on the basis of which debts can be contracted and repaid. But money ceases to perform its functions properly and satisfactorily in a highly inflationary situation when money is fast losing its value.
All the functions of money are interdependent or interconnected. When as a result of rapidly rising prices money ceases to function as a standard of deferred payment, it also ceases to act as a store of value is being fast eroded. In India, for instance, in 1974, instead of keeping bank balances, people were eager to invest in real estate or keep jewellery or gold instead of cash owing to rapidly depreciating value of money.
When money can no longer function satisfactorily as a store of value, it can no longer function satisfactorily as a medium of exchange and a unit of account or a measure of value. All calculations become difficult when money is fast losing its value. Money is thus no longer a satisfactory unit of account. As for medium of exchange, when there is excessive inflation, no one is inclined to receive money because it loses value in their hands. Hence, no one likes to keep or hold money at all.
Essentials of Good Money:
From the above discussion, one can easily infer what the essentials of good money can be:
(a) The basic ingredient of good money is that, it must be stable and not rapidly change in value,
(b) It must then be a generally acceptable medium of exchange,
(c) It must be a suitable store of value.
(d) It must be a suitable store of value,
(e) Being generally acceptable, it should be capable of transferring value.