Money – What is it?

Money is the most powerful and pervasive secular force on the planet. Yet for most, it is a source of mysticism and mystery.

Dick Wagner, JD, CFP

Ask 10 people to define money and you will probably get 10 different answers!  Similarly, ask people where does money come from?

Attributes of Money

Money is a human invention created to represent value for the purpose of facilitating trade.

The ideal attributes of money are:

  • A common medium of exchange
  • A unit of account
  • A stable store of value – over the short and long term.
  • Portable
  • Durable
  • Divisible
  • Interchangeable
  • Tamper proof

Throughout time, societies have chosen various instruments as money.  For Example: shells and stones, grain, salt, coins metals, printed notes and bills, and numbers on a computer screen.  No monetary instrument, past and present, has been able to satisfy all these attributes.

There are two degrees of separation between the value of things and money:

Value (of things) –> Numbers (quantification) –> Money (tangible instruments)

We normally see money as directly representing the value of things (that is one degree of separation). So we find it difficult to understand the money / value relationship. Much of the world’s fiscal woes has to do with manipulating the number and value of tangible instruments in circulation.

An Aside

Take, for example, inflation which is the manipulation (reduction) in the spending power (value) of the monetary instrument. Fiscal authorities can manipulate inflation by adjusting the money supply (the amount of money in the economy). Increasing the money supply means there is more money in the economy representing the same value. Therefore, reducing the value of each item of money. It is not correct to think that things getting more expensive. Inflation typically increases by small percentages annually. We generally adjust to ongoing small percentages of inflation grumbling about our gradual decline in standard of living. However, looking back, in the 1960’s most families could live comfortably on on single non skilled income. These days, many struggle to support a family on two professional incomes.

Common Medium of Exchange

Any  group of people wishing to trade could agree on an instrument to use as a common medium of exchange.  This agreement could be by mutual consent or by legal decree.  Mutual consent is group agreement on the instrument of money to use. Legal decree usually occurs where the instrument (usually coins and notes) are legislated and controlled through governments.

Legal decree instruments mostly have fractional or no intrinsic value.  That is why they require laws to enforce their value.  Countries do not necessarily trade freely other country’s currencies. Currencies currently in use around the world are examples of legal decree instruments.

Unit of Account

Money has a denomination printed or stamped on it, indicating the units of account it represents.  Weighing grain or salt served the same purpose in earlier times.

Stable Store of Value

Money retains it’s value over time.  The same amount of money buys the same amount of goods and services now. As it did a thousand years ago, and will do in a thousand years time.

Inflation reduces the purchasing power of money over time. That is in the future, the same value requires more money to purchase.   Commodity items used as money such as gold, grain or salt can fluctuate in value due to external situations.  Items that are susceptible to inflation or fluctuations over time are not stable.  The US dollar has lost about 97% of it’s value since 1900 in relation to gold.


Money is easy to carry and transport.  In modern times things are much easier where we carry the value of money in our debit and credit cards.


Money does not wear out, breakup, disintegrate or decompose.


Money can be divided into different denominations without any change of value.  For example a single $100 bill, five $20 bills and twenty $5 bills all represent the same value.


A dollar in your hand is worth the same as a dollar in my hand.

Tamper Proof

It is impossible to debase, forge or counterfeit money.

What is Currency?

Currency is simply the money instrument of a country.

Types of Money Instruments

All the money that has been and is in existence falls under into one of the following types:

  • Commodity Money – something tangible like gold, salt, shells.
  • Receipt Money – an IOU promising the bearer the commodity backing the receipt in exchange.
  • Fractional Money – Where banks only have a fraction of the commodity backing all the receipts it had on issue. Bank runs occur when people want their commodity exchanged en-masse and the bank runs out of commodity. Money prior to 1973 was fractional.
  • Fiat Money – A simple promise to pay, nothing else, money instruments only backed by legal decree.

“The Goldsmith Dynasty”

A short fable (which somewhat correlates to history) illustrates evolution of money.

Commodity Money

A long time ago, Mr. Goldsmith observed people people using gold and silver as mediums of exchange.  This was much better than bartering, or using other commodities like salt, shells or stones.  However without an accurate scale and assaying ability, the amount of gold in a trade often was in question.  The astute and enterprising Mr. Goldsmith realized that trade would be a lot easier if gold was standardized in weigh and purity.  Mr. Goldsmith started minting coins in various denominations with guaranteed purity.  These coins were very attractive to traders who gladly exchanged their gold for the gold coins.  Mr Goldsmith had created a new revenue stream for himself, charging for the service of minting the coins.

Receipt Money

Coins are vulnerable to theft.  People new that Mr. Goldsmith had a securely guarded vault, and for a small fee, stored their money there.  Thus creating another revenue stream for Mr. Goldsmith.  Mr. Goldsmith issued deposit receipts (effectively claim checks or I.O.U.’s) to the people for the gold stored in the vault.  The bearer of the deposit receipt could always redeem the amount of gold specified on the receipt.  Soon people started using deposit receipts as a medium of exchange.  These receipts were “as good as gold”.

Upon observing people trading with deposit receipts, the astute Mr. Goldsmith realized that people would readily use deposit receipts if they had the same denominations as coins. Thus the evolution of deposit receipts into receipt money.

The enterprising Mr. Goldsmith, at this time also established a gold loan business division, where he charged interest lending his gold to borrowers.  Lenders also preferred to use receipts for instead of the gold they were borrowing. The same deposit receipts could be issued to depositors of gold as well as the borrowers of gold. The receipts that the lenders held was backed by the corresponding amount of gold that Mr. Goldsmith owned and held in his vault.

Fractional Money

Lending against Deposits

Mr Goldsmith noticed that depositors very seldom redeemed their gold. And, he was holding much more depositor’s gold than his own.  By issuing loan deposit receipts backed by depositors’ gold he could earn a whole lot more interest. Setting the morality of this aside, Mr Goldsmith was issuing two deposit receipts for the gold deposited in the bank. One receipt to the owner of the gold, the other to the borrower of the gold. The rewards of doing this greatly outweighed the risks. He ensured his borrowers were credit worthy. He also kept a small reserve of gold aside for loan defaults and depositor withdrawals. Thus the evolution of deposit receipts into fractional money, backed by 50% reserves. Without an internal audit of Mr. Goldsmith’s accounts, it is impossible to determine that a deposit receipt has been issued against Mr. Goldsmith’s gold or the gold of his depositors.

In time Mr Goldsmith became exceptionally wealthy.  His depositors became suspicious, thinking he was spending their gold.  The depositors demanded their gold back, fearful that Mr. Goldsmith would not have their gold.  Mr. Goldsmith showed the depositor that he indeed still had their physical gold.  The truth of the situation was that Mr. Goldsmith had twice issued deposit receipts against the gold. One to the depositor and was charging service fees for keeping the gold. The other to borrowers as interest bearing debt.

Interest to Depositors

Eventually depositors clued into this ploy. The shrewd Mr. Goldsmith avoided being mauled by his depositors by agreeing to pay interest on deposits and waived the storage fee. Although he was earning less net income on depositors’ gold, he had gained their cooperation. He was also receiving more gold deposits to lend out because of the interest paid. This outcome may appear more fair, but it also makes the depositors accomplices to Mr. Goldsmith’s deception.  Both the depositors and borrowers still have deposit receipts in hand for the same physical gold.

Mr Goldsmith had created the first bank, paying a lower interest on the deposits of other peoples’ money and lending the money at higher interest to borrowers.  The difference in the interest received and interest paid, covered Mr. Goldsmith’s operating costs and profits.

The more Mr. Goldsmith’s wealth grew, the more greedy and brazen he became.  Demand for credit was increasing as the world was becoming industrialized and Europe was spreading out across the world.  Mr. Goldsmith’s saw he could increase his fractional rate from 50%, eventually to 10%. That is ten deposit notes for the equivalent amount of gold in reserve. As long as many depositors did withdraw their gold simultaneously, none would be the wiser. 

Fiat Money

Over time Mr. Goldsmith’s ostentatious wealth again attracted the suspicion of the deposit receipt holders, who on mass demanded their gold.  The tsunami of deposit receipts being claimed depleted the small amount of gold at the bank.  Mr Goldsmith’s most feared nightmare came true. With insufficient gold to back deposits the bank collapsed, wiping out the wealth of Mr Goldsmith and that of most of the depositors. The bank’s deposit receipts were worthless, no other bank would honour them.

This may have been a good time to outlaw the practice of creating money from (almost) nothing. But this was a time when Europe was intent on colonialising the rest of the world, and the industrial age was in full swing. The demand for credit was immense. So instead, governments intervened by creating sovereign central banks and currencies. Governments regulated banking practices (including fractional banking), the value of money and the amount of money in circulation.

The intent of government regulations was to protect Joe Citizen from having his wealth decimated. But, being in control of the regulations, governments soon implemented ways to feed their insatiable need for for money. Politicians need money to fund the promises they make to keep them in power. Governments work with the banks to introduce money into the economy as debt. Over time Governments gradually increased the fractional rate to create more funds covered by decreasing reserves. Eventually fractional money volved into Fiat Money. Fiat money is not backed by anything tangible, only a government’s legal decree.

Wealth Transfer

Why is it that fiscal authorities set inflation ranges above zero? Why is it fiscal authorities tell people that inflation is necessary for a functioning economy? Giving thought to governments and inflation, we can see that:


  • Governments all over the world, appear to have and insatiable appetite for money. The promises that Politicians make to stay in power need to be funded.
  • The only two legitimate sources of money open to government is levying taxes and issuing bonds.
  • Generally only a small portion of funds raised goes towards improving the value of the economy through public works. The majority of the funds go towards covering existing debt, social programs, defense and security.
  • Governments rely on the services of banks to issue their bonds. Banks are handsomely compensated for their part in selling bonds. Financial institutions (banks, insurers, investors) are the purchasers of these bonds. The day to day values of bonds fluctuate, these institutions profit from their trading of bonds.
  • The Government then in turn spends this money into the economy. The economy is not improved proportionally by the money spent into the economy. Hence there is a dilution of the value of the money in the economy. This dilution is inflationary as it now takes more money to buy the same value. It is important to note to that governments spend money into the economy at its pre-diluted value, while the populace receives the money at the diluted value.
  • Governments rely on the services of banks to issue their bonds. Banks are handsomely compensated for their part in selling bonds. Financial institutions (banks, insurers, investors) are the purchasers of these bonds. The day to day values of bonds fluctuate, these institutions profit from their trading of bonds.


  • Inflation whittles away or savings. Our savings are stored in institutions as amounts of money, that is not adjusted to account for the dilution of its value.
  • Inflation reduces the value of government debt. This is because the debt is measured in amount of money, and once created, is not adjusted to account for dilution of its value.


  • Debt takes from future prosperity to increase our current means.
  • This debt needs to be serviced. So the governments levies more taxes or issues more bonds to service the debt.

Concluding Remark

We feel poorer and poorer while noticing the financial institutions increasing profits year on year. This is because there is a well orchestrated, but rather covert transfer of wealth from the populace to these financial institutions with governments acting as facilitators. Governments borrow and tax to fund their initiatives of which only a small proportion benefits the economy. Borrowing increases money supply which is inflationary. Inflation whittles away our wealth, and the value of government debt. Banks and financial institutions are the providers and holders of this debt for which they are paid service charges and interest.

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