What Is Money?

          Before we can know how to use our money efficiently, we must first understand what money is. Money is anything that is generally accepted as a payment for goods or services. It is those individuals who use money wisely that will reap the greatest financial rewards.

There are three primary functions of money:

  1. Medium of Exchange: Money as a medium of exchange means it is an intermediary used for buying and selling goods and services. Money allows people to avoid the inconveniences of the barter system. In the times of the barter system, it was necessary for traders to have a coincidence of wants, meaning each party of the transaction would have to have exactly what the other party wanted to trade for. For instance, if I wanted to trade my livestock for shoes then I would only be able to do so if I found an individual willing to trade shoes for livestock. Money as a medium of exchange permits the value of goods to be assessed and rendered in terms of an intermediary. In this case, I could sell my livestock for a certain amount of money then use that money to purchase shoes.
  2. Unit of Account: Money as a unit of account refers to its ability to measure the relative worth of goods, services, and resources. Having a standard unit of account, such as money, makes it possible to interpret and compare prices, costs, profit, losses, etc. Using the US Dollar as a standard unit of account, for example, we can compare how much one good costs in comparison to another or how profitable one company is relative to its competitor.
  3. Store of Value: Money as a store of value simply means that it is capable of being saved, stored, and retrieved. Providing a store of value is extremely important in order to maintain an efficient economy because it enables people to transfer purchasing power from the present to the future. For instance, if you are an apple farmer you cannot store your apples to accumulate wealth because they will rot. With money as a store of value, however, you can sell your apples in season and have money to store the value of what you have produced. Other commodities that can serve as a store of value include gold, real estate, livestock, etc.
Money is typically considered to exist in three categories:
  1. M1: M1 is the narrowest definition of the US money supply and the most liquid, or the easiest form of money to enter transactions with. It consists of currency in the hands of the public as well as checkable deposits. Currency is simply coins and paper money. Checkable deposits are anything depositors can write checks on at any time for any amount they choose. The most common checkable deposits include demand deposits, negotiable order of withdrawal (NOW) accounts, automatic transfer service (ATS) accounts, and and share draft accounts.
  2. M2: M2 accounts for the M1 money supply and highly liquid financial assets that can be readily converted into currency and checkable deposits. In addition to M1, M2 includes savings deposits, small time deposits less than $100,000, and money market mutual funds.
  3. M3: M3 includes the money supply of both M1 and M2 as well as large time deposits greater than $100,000. Therefore, M3 accounts for all of the money in circulation in a certain economy.
The United States Dollar
          
          The US Dollar is what is known as fiat currency, or currency whose intrinsic value is not directly correlated to any particular commodity. Instead of being guaranteed by a gold (or other metal commodity) standard, the US Dollar is currency simply because the US government orders that it is an accepted as a means of payment. Therefore, the US Dollar works as currency due to the faith people have in the US government to keep the value of money relatively stable.
          Essentially, the Federal Reserve controls the money supply in the United States. Like the economic value of anything else, the value of the US Dollar is derived from supply and demand. When the Federal Reserve increases the money supply in circulation, inflation occurs, which decreases the value of each dollar. Luckily, one of the primary responsibilities of the Federal Reserve is to promote sustainable economic growth while maintaining the value of the US dollar.