Money is any instrument or actual tangible document that is usually accepted as payment for services and products and as a repayment of debts, like taxes, in a specific country or socio-cultural context. Money can be in the form of banknotes (in legal terms, “money”), coins, bank-bills, and bank shares. Although money may appear to have a common description, it is a highly complex commodity and there are many kinds of money depending on its various functions and usage.
Money in the economy is typically considered as a legal tender. This means that its supply is determined by legislation. In certain countries, however, the law allows direct circulation of money rather than money being issued as a banknote. Money that circulates through banks, like banknotes, is known as circulating currency. The supply of circulating currency is limited by law and the amount issued directly corresponds to the need of the economy.
Deflation causes money to lose its value because its purchasing power decreases with the passage of time. Inflation also occurs when the economy suffers from a shortage of money. The central bank, under the control of the government, can create money out of thin air to combat deflation by pumping large amounts of money into the economy through loans or trade deficits. Large-scale commercial paper money, which is normally created by commercial banks, tends to depreciate in value as soon as it is printed. Deflationary periods are usually associated with prolonged recession, financial crises and war.
Money is the only good in an economy that cannot be produced or manufactured on its own. The production of goods, whether they are produced artificially or not, merely results in the enrichment of a few people at the expense of the majority. Money, therefore, is a function of the distribution of wealth in society. It is historically designed to ensure that the distribution of wealth stays fair – a condition that ensures the survival of human civilization. Money, therefore, is the rule rather than the exception in a civilization that depends on its economy to flourish.
Historically, money comes in three types: commodity money, cash and credit. Commodity money generally takes the form of physical assets like gold, silver and crops. This kind of money generally undergoes inflation when they are bought and sold. Cash, on the other hand, is a product of money system. This is so because cash, unlike physical commodities, can be manufactured, although its purchase costs are relatively high.
The third type, credit, is most similar to commodity money since it is backed by the same source – the productive power of the state. This, however, renders it prone to inflation. When the state increases the demand for goods, the price level rises and so does the supply. Credit, therefore, tends to decline in value as prices rise. Money, unlike commodities, is issued from a central bank that exercises control over the supply through the supply mechanism, making it the purest form of money as it is issued from a lender to a borrower.
