Types of Money and their Definitions
What is Money?
Money allows people worldwide to buy and sell products or services in exchange for it that carries a value ranging from low to high. In a word, it is used as a payment method and a medium of exchange to buy anything. Money has several forms like banknotes, cheques, debit cards, credit cards, etc. Different countries have different types of currencies that reflect different amounts of value. For instance, USD 100 in the U.S. doesn't carry the same value as INR 100 in India.
History of Money (Barter System)
Before the banknotes and currencies came, ancient people had used the barter system as a medium of exchange. They used to exchange goods to buy other goods. For example, a farmer who produces rice needs chicken meat. As there were no currencies, he sold his rice in exchange for chicken from a seller. But the value of chicken and rice isn't the same. Thus, here comes the need for money to play as a medium of exchange solely and through that, different products and services can be measured according to their value.
Properties of Money
Money has some properties that allow all people worldwide to use it smoothly. These are-
- Money must be Divisible which means when we buy something, money should have that characteristic to be allocated in different amounts or numbers.
- Money must be Fungible, which means it should allow people to interchange.
- Money must be Portable, which means it should enable people to carry it anywhere.
- Money must be Durable, which means it should last longer.
- Money should be Acceptable to people anywhere and everywhere.
- Money should be Limited in supply to maintain its circulation and inherent value.
Types of Money
Several types of money carry different definitions and characteristics in various forms. Some significant types are explained below-
When we think of money, what comes to our mind first is banknotes or coins, considered fiat money. This sort of money is used all around the globe. Money has a face worth more significant than its actual cost and is known to the public on the administration's orders. Money's valuation is essentially how well we can pay with it. Whenever people think about how often new items and products are introduced nearly every day, regular monitoring of this type of money would be a challenging process. The federal government provides the face amount of fiat money, which can be banknotes or any other medium of exchange. So the valuation of fiat isn't equivalent to its face value.
This type of money is widely used as a payment tool and a stable exchange rate. If the actual value of a coinage contains metal that has some value and is more than the current value of the metal, it is viewed as fiat money. All exchange banknotes, including the Tk, Rupees, Dollars, and Euros, are fiat money.
Commodity money might be defined as a specific product that people widely use to exchange for several other commodities. Put another way, and it seems similar to that money people are using now, although it has validity. It does have inherent value, meaning it will have a valuation, although it doesn't seem to make money. Instead, it is a valuable trading method where the value of caffeine, honey, seashells, tobacco etc., serve as a means of exchange for goods and services.
Commodity money is tangible, which means individuals can see and hold it. However, users recognise it because of its inherent quality. It has actual value, and individuals openly exchange it all in the confidence that it will be accepted.
On the other hand, other means of payment get their meaning solely mainly from the faith that individuals put in them. For example, the 20 dollar bill in my wallet is prone to purchase anyway if Bangladesh quits using it as their primary currency.
The value of fiduciary money is determined by the expectations of its monetary worth, which is based upon its expectation that it'll be widely accepted as a medium of trade. This is not recognised legal currency by the authorities, unlike fiat money, and implies that people aren't bound by legislation to use it all as a way of paying. However, if the user requests it, the issuing bank of fiduciary money guarantees to transfer it for a product or paper currency. As a result, individuals may utilise fiduciary money like conventional fiat or commodity money when they are convinced that such commitment may not be fulfilled.
Assume you need to purchase something that demands a large sum of money, yet carrying such amounts of cash is risky or problematic. This is when the concept of fiduciary money enters. Paychecks and card payments are sources of fiduciary money. It is similar to fiat in the case of having no intrinsic value. Its worth stems from the ability to trade one for another.
Fiduciary money seems to benefit from not even being currency but still allowing for the trade of products. To put it another way, we can say that when someone goes to the market to buy something, they can carry a card instead of a massive amount of paper notes or cash.
The disadvantage is that fiduciary money has to be 'certified' through the issuers, which is more complex than carrying cash. The financial institution also needs to verify that the buyer has the money to cover the agreed-upon amount placed with them. Or else it will say no. Card payments and checks both need to be approved, but card payments are significantly faster because they are digital.
Commercial Bank Money
Commercial money in the economy refers to that part of the money formed from debts issued by commercial banks. Use of this type of money is involved in activities involving cheques issued on deposit accounts. Commercial bank value is generated using a process known as fractional reserve banking. These institutions use fractional reserve banking to administer debt that is valued as much as the rate of exchange they hold. Simply put, this category of money is debt issued by commercial banks that could be transacted for actual currency or used to purchase things.
Although most of this currency is digital, it's not required. Financial institutions might also generate money before computer systems by adding funds to the financial statements.
Financial assets, sight deposits, customer deposits, short-term securities, overdraft facilities, financial debts, and consumer credit are used to describe commercial bank money.
Representative money refers to something that can be used as a transaction medium, but this money itself is not actual money. It can be traded for a good or service. A legal document or a primary symbol that is easier to keep can be used as representative money. For example, authorities may print large quantities of banknotes, like $5, $50, $500, etc. So, carrying along with representative money and making huge transactions seems more straightforward. For example, you might even get into a financial institution and request that your banknotes be swapped for equal or more excellent value in whatever item the authorities were using.
When document credentials can perhaps be traded for a vital commodity, like precious metals, they may act as a substitute for money. However, the populace must believe the certification is the same as the precious metal resources for representational money to be accepted.
Both fiat and representational money have a source of support. Representative money might be supported by various commodities or investment funds, whereas federal authorities control fiat money.