Medium of exchange

Medium of exchange

Discussion
Ask a question about 'Medium of exchange'
Start a new discussion about 'Medium of exchange'
Answer questions from other users
Full Discussion Forum
 
Encyclopedia
A medium of exchange is an intermediary used in trade
Trade
Trade is the transfer of ownership of goods and services from one person or entity to another. Trade is sometimes loosely called commerce or financial transaction or barter. A network that allows trade is called a market. The original form of trade was barter, the direct exchange of goods and...

 to avoid the inconveniences of a pure barter system.

By contrast, as William Stanley Jevons
William Stanley Jevons
William Stanley Jevons was a British economist and logician.Irving Fisher described his book The Theory of Political Economy as beginning the mathematical method in economics. It made the case that economics as a science concerned with quantities is necessarily mathematical...

 argued, in a barter system there must be a coincidence of wants
Coincidence of wants
The coincidence of wants problem is an important category of transaction costs that impose severe limitations on economies lacking money and thus dominated by barter or other in-kind transactions...

 before two people can trade – one must want exactly what the other has to offer, when and where it is offered, so that the exchange can occur. A medium of exchange permits the value of goods to be assessed and rendered in terms of the intermediary, most often, a form of money
Money
Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past,...

 widely accepted to buy any other good.

Definition


Money is the common Medium of Exchange and its most important and essential function is that it is 'measure of value'... Hifzur Rab has shown that market measures or sets value of various goods and services using the medium of exchange/money as 'unit' i.e., standard or the Yard Stick of Measurement of Wealth. There is no other alternative to the mechanism used by market to set or determine or measure value of various goods and services and therefore wealth. Just determination of prices is an essential condition for justice in exchange, efficient allocation of resources, economic growth welfare and justice.Money helps us in gaining power of buying.
Thus, this is the most important and essential function of money. To be widely acceptable, a medium of exchange should have stable purchasing power (Value)and therefore it should possess the following characteristics:
  1. value common assets
  2. constant utility
  3. low cost of preservation
  4. transportability
  5. divisibility
  6. high market value in relation to volume and weight
  7. recognizability
  8. resistance to counterfeiting

To serve as a measure of value, a medium of exchange, be it a good or signal, needs to have constant inherent value of its own or it must be firmly linked to a definite basket of goods and services. It should have constant intrinsic value and stable purchasing power. Gold was long popular as a medium of exchange and store of value because it was inert
Inert
-Chemistry:In chemistry, the term inert is used to describe a substance that is not chemically reactive.The noble gases were previously known as inert gases because of their perceived lack of participation in any chemical reactions...

, was convenient to move due to even small amounts of gold having considerable value, had a constant value due to its special physical and chemical properties, and was cherished by men.

Critics of the prevailing system of fiat money
Fiat money
Fiat money is money that has value only because of government regulation or law. The term derives from the Latin fiat, meaning "let it be done", as such money is established by government decree. Where fiat money is used as currency, the term fiat currency is used.Fiat money originated in 11th...

 argue that fiat money is the root cause of the continuum of economic crises, since it leads to the dominance of fraud, corruption, and manipulation precisely because it does not satisfy the criteria for a medium of exchange cited above. Specifically, prevailing fiat money is free float and depending upon its supply market finds or sets a value to it that continues to change as the supply of money is changed with respect to the economy's demand. Increasing free floating money supply with respect to needs of the economy reduces the quantity of the basket of the goods and services to which it is linked by the market and that provides it purchasing power. Thus it is not a unit or standard measure of wealth and its manipulation impedes the market mechanism by that it sets/determine just prices. That leads us to a situation where no value-related economic data is just or reliable. On the other hand, Chartalists
Chartalism
Chartalism is a descriptive economic theory that details the procedures and consequences of using government-issued tokens as the unit of money. The name derives from the Latin charta, in the sense of a token or ticket...

 claim that the ability to manipulate the value of fiat money is an advantage, in that fiscal stimulus is more easily available in times of economic crisis.

From barter to exchange


Although the unit of account
Unit of account
A unit of account is a standard monetary unit of measurement of value/cost of goods, services, or assets. It is one of three well-known functions of money. It lends meaning to profits, losses, liability, or assets....

 must be in some way related to the medium of exchange in use, e.g. coinage
Currency
In economics, currency refers to a generally accepted medium of exchange. These are usually the coins and banknotes of a particular government, which comprise the physical aspects of a nation's money supply...

 should be in denominations of that unit making accounting much easier to perform, it has often been the case that media of exchange have no natural relationship to that unit, and must be 'minted' or in some way marked as having that value. Also there may be variances in quality of the underlying good which may not have fully agreed commodity
Commodity
In economics, a commodity is the generic term for any marketable item produced to satisfy wants or needs. Economic commodities comprise goods and services....

 grading. The difference between the two functions becomes obvious when one considers the fact that coins were very often 'shaved', precious metal removed from them, leaving them still useful as an identifiable coin in the marketplace, for a certain number of units in trade, but which no longer had the quantity of metal supplied by the coin's minter. It was observed as early as Oresme, Copernicus and then in 1558 by Sir Thomas Gresham
Thomas Gresham
Sir Thomas Gresham was an English merchant and financier who worked for King Edward VI of England and for Edward's half-sisters, Queens Mary I and Elizabeth I.-Family and childhood:...

, that bad money drives out good in any marketplace (Gresham's Law
Gresham's Law
Gresham's law is an economic principle that states: "When a government compulsorily overvalues one type of money and undervalues another, the undervalued money will leave the country or disappear from circulation into hoards, while the overvalued money will flood into circulation." It is commonly...

 states "Where legal tender laws exist, bad money drives out good money"). A more precise definition is this: "A currency that is artificially overvalued by law will drive out of circulation a currency that is artificially undervalued by that law." Gresham's law is therefore a specific application of the general law of price controls. A common explanation is that people will always keep the less adultered, less clipped, sweated, less filed, less trimmed coin, and offer the other in the marketplace for the full units for which it is marked. It is inevitably the bad coins proffered, good ones retained.

The fact that a bank
Bank
A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...

 or mint
Mint (coin)
A mint is an industrial facility which manufactures coins for currency.The history of mints correlates closely with the history of coins. One difference is that the history of the mint is usually closely tied to the political situation of an era...

 has always been able to generate a medium of exchange marked for more units than it is worth as a store of value, is the basis of banking. Central banking is based on the principle that no medium needs more than the guarantee of the state that it can be redeemed for payment of debt
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...

 as "legal tender
Legal tender
Legal tender is a medium of payment allowed by law or recognized by a legal system to be valid for meeting a financial obligation. Paper currency is a common form of legal tender in many countries....

" - thus, all money equally backed by the state is good money, within that state. As long as that state produces anything of value to others, its medium of exchange has some value, and its currency may also be useful as a standard of deferred payment among others, even those who never deal with that state directly in foreign exchange.

Of all functions of money, the medium of exchange function has historically been the most problematic because of counterfeiting, the systematic and deliberate creation of bad money with no authorization to do so, leading to the driving out of the good money entirely.

Other functions rely not on recognition of some token or weight of metal in a marketplace, where time to detect any counterfeit is limited and benefits for successful passing-off are high, but on more stable long term social contract
Social contract
The social contract is an intellectual device intended to explain the appropriate relationship between individuals and their governments. Social contract arguments assert that individuals unite into political societies by a process of mutual consent, agreeing to abide by common rules and accept...

s: one cannot easily force a whole society to accept a different standard of deferred payment, require even small groups of people to uphold a floor price for a store of value, still less to re-price everything and rewrite all accounts to a unit of account (the most stable function). Thus it tends to be the medium of exchange function that constrains what can be used as a form of financial capital
Financial capital
Financial capital can refer to money used by entrepreneurs and businesses to buy what they need to make their products or provide their services or to that sector of the economy based on its operation, i.e. retail, corporate, investment banking, etc....

.

It was once common in the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...

 to widely accept a check (cheque
Cheque
A cheque is a document/instrument See the negotiable cow—itself a fictional story—for discussions of cheques written on unusual surfaces. that orders a payment of money from a bank account...

) as a medium of exchange, several parties endorsing it perhaps multiple times before it would eventually be deposited for its value in units of account, and thus redeemed. This practice became less common as it was exploited by forgers and led to a domino effect
Domino effect
The domino effect is a chain reaction that occurs when a small change causes a similar change nearby, which then will cause another similar change, and so on in linear sequence. The term is best known as a mechanical effect, and is used as an analogy to a falling row of dominoes...

 of bounced checks - a forerunner of the kind of fragility that electronic systems would eventually bring.

In the age of electronic money
Electronic money
Electronic money is money or scrip that is only exchanged electronically. Typically, this involves the use of computer networks, the internet and digital stored value systems...

 it was, and remains, common to use very long strings of difficult-to-reproduce numbers, generated by encryption
Encryption
In cryptography, encryption is the process of transforming information using an algorithm to make it unreadable to anyone except those possessing special knowledge, usually referred to as a key. The result of the process is encrypted information...

 methods, to authenticate transactions and commitments as having come from trusted parties. Thus the medium of exchange function has become wholly a part of the marketplace and its signals, and is utterly integrated with the unit of account function, so that, given the integrity of the public key system on which these are based, they become to that degree inseparable. This has clear advantages - counterfeiting is difficult or impossible unless the whole system is compromised, say by a new factoring algorithm. But at that point, the entire system is broken and the whole infrastructure is obsolete - new keys must be re-generated and the new system will also depend on some assumptions about difficulty of factoring.

Due to this inherent fragility, which is even more profound with electronic voting
Electronic voting
Electronic voting is a term encompassing several different types of voting, embracing both electronic means of casting a vote and electronic means of counting votes....

, some economists argue that units of account should not ever be abstracted or confused with the nominal units or tokens used in exchange. A medium is just that, a medium, and should not be confused for the message.

See also

  • Authentication
    Authentication
    Authentication is the act of confirming the truth of an attribute of a datum or entity...

  • Check
  • Commodity money
    Commodity money
    Commodity money is money whose value comes from a commodity out of which it is made. It is objects that have value in themselves as well as for use as money....

  • Forgery
    Forgery
    Forgery is the process of making, adapting, or imitating objects, statistics, or documents with the intent to deceive. Copies, studio replicas, and reproductions are not considered forgeries, though they may later become forgeries through knowing and willful misrepresentations. Forging money or...

  • History of money
    History of money
    The history of money spans thousands of years. Numismatics is the scientific study of money and its history in all its varied forms.Many items have been used as commodity money such as natural scarce precious metals, cowry shells, barley, beads etc., as well as many other things that are thought of...

  • Identity theft
    Identity theft
    Identity theft is a form of stealing another person's identity in which someone pretends to be someone else by assuming that person's identity, typically in order to access resources or obtain credit and other benefits in that person's name...

  • Private currency
    Private currency
    A private currency is a currency issued by a private organization. It is often contrasted with fiat currency issued by governments or central banks. In many countries, the issue of private paper currencies is severely restricted by law....


External links