A Measure

A Measure

A second important function of money is to act as a measure of
value. A common medium of exchange allows you to put a price, or
exchange value, on all things in trade and it is by the operation of
the price mechanism that signals of shortages and surpluses can
thus be conveyed to all consumers and producers in a market
society. Note that no given form of money can fulfil this essential
Box 5.2 The Gold Standard and fixed exchange rates
Prior to the First World War, the currencies of all major trading
nations were freely convertible into gold at a fixed exchange rate.
This implied they were simultaneously all fixed with one another.
Any nation in debt to another would pay the difference in gold
and the outflow of reserves from one country would enforce a
contraction of money supplies, just as a gold inflow would
prompt a monetary expansion. Different countries can only fix
their currency exchange rates between themselves over time,
however, if they all grow in wealth at the same rate. After the
Second World War, the rapid economic growth of West Germany
and Japan, in particular, meant that by the 1970s the
Deutschmark and the Yen possessed an intrinsic worth greater
than their Bretton Woods value fixed in the 1940s. A realignment
of exchange rates was long overdue and since there was no
agreement on fixed values in the inflationary 1970s, exchange
rates were left to float, or vary, according to demand and supply.
© 2004 Tony Cleaver
signalling function if its own value is subject to variation. Hence
the importance of containing inflation.
Measuring value requires some baseline to which all prices can be
compared and it also requires a scale of units. The baseline against
which money itself is valued is a SAMPLE BASKET of everyday
commodities – a long list of items which the ‘average household’ in a
society will buy and which is weighed according to their relative
importance. (A 10 per cent rise in the price of bread will imply a
more important fall in the value of money than a 100 per cent rise in
the price of golfballs, for example.) All governments appoint statisticians
to compile records and regularly calculate whether or not, and
by how much, inflation has risen and the value of money fallen.
All modern money has a metric scale of units nowadays, though
it was only in 1971 that the UK changed from 240 to 100 pennies
per pound. The larger the number of divisible units, the finer the
gradations of value can be signalled, though you might argue it is
meaningless to retain units that are smaller than any perceivable
differences in value (if one UK pound exchanges for 194.7 yen
which equals 1.8 US dollars, what is one yen really worth?).
A Store
Money should act as a store of value – if it is perishable in any way
then it cannot safely be banked. It makes no sense to accumulate
money if it costs to do so – people might as well stockpile all sorts
of other assets with intrinsic value instead (salt?). Note the accumulation
of capital allows the financial services industry to grow and
to invest in all sorts of productive enterprise. People all over the
world put their savings into pension funds so that they have some
income when they retire. This is only possible if people can trust
their money to hold its value over time. What distinguishes ‘hard’
currencies from ‘soft’ ones (terms used at times by financial journals
to describe various currencies) is that the former are a better
store of value – they are less likely to suffer inflation. This function
then facilitates a major feature of all modern money: the ability to
buy now and pay later.
Take care – not all that is a good store of value is necessarily
money. The price of fine wine increases with age and if you have
a lockable cellar it costs little to keep it. Similarly you can have
© 2004 Tony Cleaver
a safe full of stocks and shares that will more than keep their value.
Are they money? No. That is because an essential feature of money
is that it is a perfectly LIQUID ASSET that is exchangeable at any time,
at no cost, for anything you want. Selling off wine or stocks and
shares for their full present value (which may have appreciated
considerably) means you have to wait for an appropriate buyer.
Money, on the other hand, is perfectly transferable or convertible at
an instant’s notice. It wouldn’t be money otherwise.
A Standard
Money functions as a standard for deferred payment which allows
consumers to buy expensive items (houses, cars) over a phased
time period, enables producers of such goods to sell more and
better regulate their income streams, and provides the opportunity
for bankers to create all sorts of innovative forms of debt and paper
money. Even if the particular form of money in question is a poor
store of value, so long as its value deteriorates (i.e. inflation rises) at
a predictable rate then a compensating rate of interest can be
charged and deferred payment still accepted. (You agree to loan me
85 ducats today for the period of one year. Suppose that in order to
compensate you for the opportunity cost of that money – that is,
the sacrifice of you not using that sum for 12 months and giving it
to me instead – we agree on a deal of an extra 15 ducats. Thus I
should pay you 100 next year. But if the rate of inflation of ducats
is 10 per cent over the year then I am going to have to pay you 110.
Agreed? If so, we can do business even in a ‘soft’ currency.)
T H E F O R M S O F M O N E Y
As has been illustrated already, money comes in many different
forms: such as given weights of precious metals that have since
evolved into coins and notes. The former were originally standardised
units of precious metals – like the UK gold sovereign which
was a specific cut and design of gold stamped with the sovereign’s
head to authorise its value. The latter were originally promises to
pay a given weight of precious metal. Coins and notes now are
tokens with no intrinsic value but, interestingly, they have assumed
the mythical property of ‘real money’ like gold since today what
© 2004 Tony Cleaver
mostly changes hands in trade is not cash but pieces of paper or
plastic (cheques or credit cards) that represent cash. You know that
if shopkeepers or traders won’t accept your promise to pay then
they will accept cash (someone else’s . . .). The transaction is the
same, the form of money has changed. In fact the form of money
changes all the time – according to what society you are dealing in
and what it best recognises and accepts. Money, like beauty, is in the
eye of the beholder.