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How Money has Developed over Time

How Money has Developed over Time

Author: James Howard

Determine the functions of money.

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Hello and welcome to this tutorial on how money has developed over time. Now as always with these tutorials, please feel free to fast forward, pause, or rewind as many times as you need in order to get the most out of the time that you'll spend here.

So let me ask you a question. What, exactly, is money? Is it the stuff that folds in your wallet? Is it the stuff that jingles in your pocket, those quarters and pennies? Or is it something different, or is it something much more? Well, I think the answer might surprise you.

What we're going to be covering in this tutorial is how money as we understand it today has developed. We're also going to look at the four functions of money. What does money do? And what's money really worth, anyway?

Well the key terms for this lesson that we're going to be looking at are the M1 money supply, the M2 money supply, and medium of exchange.

Well let's get started with how money has developed over time. Now people traditionally, when they want something that someone else has, they-- couple of ways to go about getting it, and one of those things-- more peaceful way-- is through an exchange. Now, a medium of exchange is simply an item that allows a simplified sale or purchase process.

Traditionally, before we had easy mediums of exchange, we did what was called bartering. Now, bartering is something where I'd have a direct exchange of goods between two people. Let's say I have a carpenter here, and he's really thirsty, and he'd like a glass of milk, or he'd like a lot of milk. So he finds a dairy farmer and they work out a deal where the carpenter will build the dairy farmer a chair because he wants a chair, and the dairy farmer gives the carpenter some milk because he wants some milk.

Well, you see where this is beneficial for both parties, but also, there can be a problem, because now the dairy farmer already has a chair. So when the carpenter wants some more milk, now what does he do?

So what we ended up doing was, individuals began to accept things that were considered universal, a universal exchange. For instance, let's say the carpenter in this case builds a chair or something for a miller, and in exchange, he got a big sack of flour. Well then when he wanted something, something from somebody else, like milk, for instance, he could simply trade cups of flour for that milk, and that helps serve as that medium of exchange.

The flour became that thing by which he could exchange the product for product and get the things that he wanted or needed. It was portable and divisible. And also, flour could be stored for a long period of time without spoiling, so it also serves as something that's durable.

That's kind of how this whole idea as we know it today of money really started. So what are the four functions of money? Well for one thing, money has to be portable. It wouldn't be any good, or very much fun, if you had to carry 40 pounds of metal coins everywhere you go, or you're using fresh milk and you had to carry that around, for instance, as your medium of exchange. It wouldn't last very well, and well, you'd be stinky in no time.

Now, governments eventually began to create their own money with stamped metals, and later on with printed paper to help with this portability issue. Then the next thing that money has to do, or the next function that money serves is, it has to be divisible. If I only wanted a loaf of bread, a hundred dollar gold coin is not going to do me much good. And how many cups of milk equals a loaf of bread?

So you have to be able to divide it. You can't simply have one big rock or stone that you trade for one thing. It has to be divisible to really serve and function well as money. Half a chair doesn't work, going back to the carpenter. Also, it has to be durable. Imagine using fresh milk as your money source. It's only good for a day or so, so it wouldn't be very durable, and it wouldn't last for very long as a type of money. And lastly, it has to be stable.

Again, milk. If you're losing value every moment that you're holding it because it's steadily going bad, it doesn't stay stable very long. So these are the four functions that money really needs to serve.

Well, what is money really worth? Anyway, for money to serve its purpose, people have to agree on what it's worth. There has to be an agreed upon value between the two parties. And this is done in part by the supply of money that's out there. The more money that's out there, generally, the less the value is.

When money supply goes up, the value goes lower, and when the supply goes down, because there's less of it out there and people want more of it, because that supply is low, the value of that money tends to go up.

Now it can be a challenge to measure money in this way, especially when you're looking across national boundaries, because, again, you have to come to some consensus as to what this money is worth. And typically, businesses watch money supply as a reflection of the economic health a country.

As money supply increases, so the economy is considered to be more healthy. That means that the economy is growing and money is being created within the economy. So up to a point, growing money, or increasing money in the economy is considered a good thing.

Well, let's take a look at two different types of money supply that are generally in the economy that we're going to be looking at to assess a country's economic health. One is M1 money supply. Now this is money that is either physical money or immediately accessible through an account, such as a checking account. Now this can also include cash, checks, any demand deposit. And its considered the money that's most or most spendable right now. The thing that I can get my hands on the fastest.

Then we have the M2 money supply. And this is all the money that is in the M1, plus funds or investments that are easily converted into cash, such as a saving account or money market fund. And this includes anything like monies that are convertible into CDs, or certificates of deposit, money market accounts, and again, you can throw savings accounts in here also.

Well here is an example of a money supply growth chart for M1 and M2. Now, this particular one has M3, don't worry much about that. What we're going to focus on is the M1 and M2 money supply. And this is in billions of US dollars.

And what you'll notice here is from the '60s all the way through the '70s, as far as US billions of dollars here in the '80s, you had a steady growth of money supply up until the mid '90s, and then things started to shrink just a little bit in the M1.

In the M2, however, you'll see that right there at the '90 and the mid-'90, '95, you had that little pause, and then it continued to go up. So as far as immediately convertible cash and as far-- and billions of dollars, the M1 was holding steady or retreating a little bit in the early 2000s. It's just started to come back.

And stuff that was less liquid, like CDs and investments and stuff started-- kept climbing higher and higher here, and down here as a percentage of total, you'll see M1 steadily shrinking as a percentage. So there's less and less immediately convertible cash here and more and more in the M2.

So what is it we learned today? Well, we looked at how money has developed over time. We also look at those four functions that money serves. And we looked at what money's worth is, how a generally expanding economy will generally have a higher amount of money involved.

Now as always. I want to thank you for spending some time with me today, and you folks have a great day.

Terms to Know
M1 Money Supply

Money that is either physical money or immediately accessible through an account such as a checking account.

M2 Money Supply

All of the money that is in the M1, plus funds or investments that are easily converted into cash such as a a saving account or money market fund.

Medium of Exchange

An item that allows a simplified sale or purchase process.