Money in the Management of Our Economy

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“Money is the opposite of the weather. Nobody talks about it, but everybody does something about it.” – Rebecca Johnson

Money is one of the greatest inventions of humankind. It is the most fascinating aspect of economics. Money bewitches people. Persons suffer because of money and are working for it. They come up with the most clever ways to get it, and most clever ways to spend it.

According to the modern definition of money, it is a special kind of universal product used as a global equivalent, the cost of which is defined by the cost of all other commodities. Money is a unique product that serves as a medium of exchange, payment, measurement of value, the accumulation of wealth. In today’s economy the circulation of money is unchanged condition handling the circulation of almost all types of goods. The nature of money is not fixed once and forever or frozen in its development. Currently, it is particularly important as an element of market relations.

With the development of market relations and improvement of management methods there is a need for an in-depth study of economic content of money in order to enhance the efficiency of social production. High requirements for economic management methods necessitate the study of monetary mechanism as one of the constitutive elements of the entire economic system. In the competition among participants in the process of reproduction, success comes to those who are more aware of modern methods of use of money and banking technology.

Barter Economic System

As known from history, the ancient equivalent of modern currency was often animal skins, grain, salt, cloth, shells, ornaments and even dried fish. In addition, the so-called barter was the first way of market interaction, allowing people to get food and clothing in exchange for other products.

Exchange system, in which the individual having a need for goods or services must find another individual who wants to provide his or her products and services in exchange for other goods and services, called a system of pure barter. In other words, an individual who has a product A, hoping to sell it and buy a product B, must find another individual having the item B, who wants to sell it and purchase, accordingly, the product A. Inconvenience provided by the pure barter system forced people to look for the other ways to communicate in the market. The organization of special trading venues where goods and services are presented was one of them.

Exchange system, whereby individuals on a regular basis exchange goods and services directly for other goods and services, is called barter trade system. Establishment of specialized marketplaces allowed potential buyers to know in advance where they could find sellers of specific products. Although this method reduces the problems of sharing a double coincidence of needs, it did not remove the inconvenience completely, as well as did not exclude expenses related to it. Particular individual knew what product he wanted to exchange, but he or she did not always know what kind of product or service the seller wanted to get in return.

Pure barter system has four major drawbacks:

  • there is no way to preserve the general purchasing ability. Barter allows people to save only specific purchasing ability of goods which can be changed for the reason of physical changes in product, modifications in consumer tastes or the situation on the market;
  • “If a person wants to buy a certain amount of another’s goods, but only has for payment one indivisible unit of another good which is worth more than what the person wants to obtain, a barter transaction cannot occur. What if after you trade two goats for the rotisserie chicken you decide you want a 20 oz. bottle of Coke to go with it, but a bottle of Coke trades for another two goats? Both you and the store owner want to make a deal, but half a 20 oz. Coke is worthless since it will go flat, and you cannot afford a whole Coke, so no deal can be made. This creates inefficiency as well, since both individuals would like to trade, and you both value each other’s goods more than you value your own, so total societal utility could be increased by a trade.”(Bartering, n.d.).
  • there is no single measure of value. In a barter economy the individual is supposed to express the price of any good or service in the quantities of all other goods or services;
  • there is no defined unit of payment. At the time of execution of payment agreed, market price of goods or services may be changed considerably.

Despite the multiple disadvantages of the barter exchange methods, great societies, like the Inca civilization in South America in the XV-XVI centuries managed to achieve a high level of development without the use of money. Of course, the role of barter relations has been steadily declining, but even in the XXI century barter can successfully coexist with monetary forms of exchange. If the production of goods and services is limited, and the number of sales transactions is small, or there is a shortage of available cash, barter has a good chance to replace money as a means of payment. This was confirmed by the economic experience of the countries of the former socialist camp in the 70-90s of the XX century. Moreover, it is either demonstrated as a practice in the economy of Cuba and some African countries. Even within the electronic economy, which began to emerge in the 1990s, the electronic barter plays definitely not the last role in the modern society.

A Brief History of Money

Analyzing the information mentioned above, it is obvious that barter economic system can coexist with monetary system, but can never replace it. To understand it, let us imagine modern economic system without money as currency. It is a funny absurd and nothing more. For example, an economist who wants to get a haircut would be supposed to find a barber who would like to hear a lecture on economics. Another example is an actor, who wants to get a new coat, would have nothing to do but find a tailor who is interested in his role in the films. Money eliminates the need for such a pair matches of the wishes of potential partners and allows to choose a place and time of the transactions, the quality and quantity of goods exchanged, the partners in the transaction, etc. In an economy, where there is an agreement about the universal equivalent, individuals can easily make up the exchange ratio. If one knows the price of the two items, their relative value is obvious. It must be emphasized that since their inception barter relations objectively gravitated toward finding a convenient product that could act as a universal equivalent in the market, such as bronze, iron, copper, silver, gold. When calculating one had to weigh bars of metals on the scales, but sometimes it was necessary to divide the bars into smaller pieces. The need for a universal equivalent led to the emergence of the standardized bars with guaranteed weight.

Later, some types of bars of metals were supplied with notches, which was convenient to divide them into parts. These improvements, however, did not relieve the need for traders to weigh bars and parts when making calculations. Growth of goods production and the expansion of barter contributed to further improvement of the meal bars, which was the introduction of coins. The first metallic coins, equal in weight and size, appeared in China in the XII century BC. Gradually, they acquired a round form, convenient for production and use.

For many centuries, until the beginning of the 1800s, the circulation of gold and silver coins that had the same status represented monetary systems in most countries. The price ratio between gold and silver was not officially fixed, but determined by market mechanisms. During the period from 1816 to 1900, most countries moved to the gold or gold coin standard. The price of the coin was equivalent to the cost of the contained gold. At the same time, the cost of steel small coins usually in one way or another has also been tied to the gold coin price.

By the beginning of the First World War, almost all countries stopped the circulation of gold and silver coins in order to build strategic military stocks. This created a fundamentally new monetary system, which was formed not on real money, having its own value, but was based on its surrogates, which were called “currency” – bills, treasury notes, coins made from inexpensive metals. In the 1976 gold stopped serving as the world’s money.

Characteristics of Money

  • Money has a stable value that depends on the constancy of its purchasing power in commodities and foreign currencies.
  • Money is of low costs of its circulation, which is manifested in minimizing the cost in its manufacturing.
  • There is no term limit in the use of money, which is provided by the durable paper or metal.
  • For money to preserve its value, it has to be of limited supply. The supply of money is controlled by the Federal Reserve so there is no devaluing of money over time (Reserve Bank of Saint Louis, 2013).
  • Money has the characteristic of divisibility of large money bills in value into smaller ones, which makes it possible to realize any payment.
  • Money is portable, which results in a high ease of use of money in everyday life.

Kinds of Money

Most people are used to the fact that the bills and coins represent money; however, it is not true. Here are the most widely spread kinds of money in the modern society.

  • Paper currency is the bank notes, which are created by the State to cover their costs. Paper money first appeared in China in the VIII century. It must be emphasized that the paper currency is prone to inflation. Instability of paper money circulation is primarily concerned with the fact that the issue of paper money is governed not so much by the need of money, as by the ever-growing needs of the state financial resources, in particular, to cover the budget deficit. In addition, there is no mechanism of automatic withdrawal of excess paper money from circulation.
  • Credit money is used when a sale is made on credit. Their occurrence is associated with the function of money as means of payment. In this case, credit money represents the obligation that must be repaid in a predetermined period by the real money. In the early days the goal of credit money was to save paper and metal money and to contribute to the development of credit relations. Gradually, with the development of capitalist relations the essence of the credit money is changed.
  • Plastic cards are an important attribute of modern business, creating the perfect tool for customer loyalty and improving discipline among the employees. Plastic cards characterize a high level of company image and make it more attractive to consumers. Plastic cards are used to identify their owner, as an analogue of the means of payment, as a “ticket to the world of discounts, and for a combination of any of the characteristics listed above.
  • Smart card is a plastic card with integrated electronic circuits. In most cases, smart cards usually contain a microprocessor, operating system, controlling device, and an access to objects in its memory. Additionally, smart cards usually have the ability to conduct the cryptographic calculations. Appointment of smart cards is user identification, they are the means of payment, storage of key information, and conduction of cryptographic operations. Smart cards are increasingly used in various fields, from the system of accumulative discounts to credit and debit cards, student cards, GSM phones and tickets. Smart card was invented by a Frenchman Roland Moreno in the mid-70s, but only in the late 1980s technological progress has made it convenient and inexpensive enough for practical use. Recently, increased active transition from magnetic cards to smart cards is observed. Europe, where in 1993 there were more than 350 million smart cards and memory cards released, has a leading position in this way. Most experts believe that in 10 years or less cards with a magnetic strip will become nothing more than a part of history.
  • Check is a document, which contains the order from legitimate owner of the account to pay the money to the one who got this check. Check circulation involve the following people: account holder, person taking a loan from the account holder (his or her creditor) and the payer, usually a bank or other credit institution. Checks first appeared in England in the 16th century. With time, credit system began gaining popularity, as well as the checks. Depending on the type of checks, they can either contain the name of a person who can get money, which means that he or she is not allowed to give the check to anyone else, or not, which means that there is no any specific person assigned to get the money, anyone can do it. Basically, checks are used to get cash money in the bank, or other credit institutions. Checks are used in international payments as well.
  • Electronic money has been introduced in the 20th century. In connection with the expansion of check circulation in the second half of the 20th century, humankind started requiring new forms of payments. Thanks to scientific and technical progress and the development of computer technology, people invented automated electronic systems for processing checks. These electronic devices and the ability to transmit signals at a distance without paper forms contributed to the emergence of electronic money. Electronic money is such kind of money, like any other, used as a means of payment. In other words, nowadays people can pay with paper money, as well as electronically. Electronic money is very easy to use. There are a large number of payment systems, which are cashing electronic money. Working with these systems is so simple that even a child is probably able to cash out the money. Electronic money is very easy to handle. Currently, most of the inter-bank transactions are conducted with the use of it at the global level. In more than two hundred countries electronic payments is a common thing. This is a sign that the electronic money won credibility.

Functions of Money in the USA

There are five main functions of money in the economy of the United States.

Standard of Value

This function expresses the main need for money that arouse when barter economic system no longer satisfied people. Money gives the shape of the price to the products making it possible to exchange them between each other. Using a measure of value people are able to determine the value of goods as well as using kilograms and meters they can determine weight and distance.

People wanting to exchange a product for another one they need, use the mechanism of prices and determine the final version of the exchange value of goods or the amount of money which these goods are valued at the market. Therefore, they are able to satisfy the wishes of both business operations. This in general is the economic content and expression of the function of money as a measure of value in today’s economic environment. Important fact is that money no longer serves as a measure of value in a period of high inflation in the country.

Change of Value

It is a function in which money acting as a mediator in the exchange of goods provides the circulation of them.

Nowadays, there is no any alternative to the exchange of goods with money. In other words, the exchange of goods under the scheme product – money – product is the most economical. Using money as a medium of exchange allows to move away from a barter form of payment and significantly reduces the costs of the process of exchange. Thus, by reducing costs of goods circulation money stimulates the development of production, which in turn creates a lot of extra income in the country and contributes to the overall growth of the welfare.

Money makes it possible to exchange goods on distance not depending on time. An important feature of money is that they provide a flow of goods from producer to consumer, which means that the goods move out of the sphere of circulation, while money are moving from one subject to another. In certain economic conditions, the quantity of money in circulation as a means of exchange is narrowed.

The rapid development of market economy, including the widespread use of credit results in narrowing the scope of the use of money as a medium of exchange and expanding the use of money as means of payment.

Standard of Payment

The use of money as a means of payment can be observed not only in the sale of goods on credit. As a means of payment money act in all cases where there is no direct exchange of goods for money and they serve as an independent exchange value.

Money is also the standard of deferred payment. It means that one can postpone the process of payment for future and a specific amount of money can be paid in future for which the services or expenses have been consumed currently.

Store of Value

Functioning as a store of value, money is turned into a special asset that is accumulated after the sale of goods or services and provides its owner with purchasing power in the future.

People actively use this function when they are able to earn more money than they spend. No doubt, there is an opportunity to accumulate value, not only in monetary terms. However, money is best suited to perform this function because it has high liquidity. Liquid assets are those that can easily be used as a means of payment, or easily turn into a means of payment and have a fixed nominal value.

Money as a store of value enables country to:

  • save cost for the case of political, economic and natural shocks,
  • accumulate wealth that can be spent in the future,
  • get an additional income in the future, as a treasure in the form of pieces or bars of precious metal do not bring profit to its owner.

Managing Money

Contemporary society is extremely dependent on the economic situation in our country, while economy itself is fundamentally based on the money system. Thus, ruling the economy first means managing money and regulating its supply. History shows that almost all societies periodically go through the ups and downs. Prospering times are always pleasant, while crisis economic situation are challenging. This is why the Federal Reserve was created. To make the slumps less painful it possesses several tools, which are effective in regulating the money supply.

Nowadays the central bank is granted with more functions. Thus, the Fed is up to manage money supply and regulate bank reserves to make the economy more stable. There are three effective tools which are used by the Fed to implement its primary tasks of regulating money supplies:

  • open-market operations,
  • manipulating the discount rate,
  • changing the reserve requirements.

The ratio of reserves is not often changed, although it is very effective way to manipulate money supply in this way. There is always a definite amount of reserves which are held against deposits. When the reserve ratio is decreased, it becomes possible for the bank to lend, providing an increase in the supply of money. The opposite result can be observed when the reserve ratio is increased.

The open-market operations mean selling and buying the securities of government. To increase the money supply for the public, the Fed is supposed to buy securities (for example Treasury bills). On the contrary, to decrease the money supply in the public, the Fed has to sell the security. Purchasing and selling is not associated with the actions of the public, but with the Fed. In other words, when the Fed buys, the public sells. This is what an open-market purchase means. However, the Fed never performs open-market operations among the public; it does it with banks and the largest securities dealers of the country. When the Fed purchases the securities in an, the seller is likely to receive a check drawn on the Fed itself. In case the seller puts it on the deposit in the bank, it will increased reserve balance with the Fed automatically. Thus, the new reserves are allocated for additional loans. By the application of this process, the money supply in the market increases (Cloutier, 2011).

To get a deposit, bank has to make a loan. This increases the money supply more effectively than any other operation. Using this way in regulating money supply is often called the money multiplier. Bank credit is loans and purchases of securities. The holding of bank credit increases the money stock as compared to the monetary base. This phenomenon is also known as “high-powered money”. High-powered money consists of currency and bank deposits at the Fed (Cloutier, 2011).

The Dollar and its Role as a Global Reserve Currency

In contemporary world one can hardly find a country where it is impossible to pay cash in dollars for any goods or services. The role of the U.S. dollar really seems to be “disproportionate privilege” – from the point of view that even foreign exchange transactions between the countries with the lowest trade as compared to the United States are carried out in dollars. The economist from the University of California at Berkeley Barry Aiken Grin wrote rather an interesting book concerning this topic, where he gave the following example: South Korea and Thailand denominate their exports by 80 % in U.S. dollars, although the total amount of their exports directed to the U.S. is only 20%. Or another example: a wine merchant from South Korea buys a game of Chilean wines and pays with the U. S. dollar, but not the Chilean peso instead. 85 % of all international trade transactions, writes Professor Aiken Grin in the newspaper The Wall Street Journal, are made in U.S. dollars.

Aiken Grin notes another point: the attractiveness of the dollar reflects the unique depth of the markets concentrated on the sale of dollar-denominated debt securities. The scale of these markets makes the dollar the most convenient currency for business, and this is equally referred to corporations, central banks and governments.

Due to its “disproportionate privileges”, the U.S., unlike most other country, can pay for the import with their currency. Other countries have to purchase imports first to earn dollars through export.

However, different countries of the world have far more dollars than they need for the exports from the U.S.: dollars are paid in mutual trade without America as well. Central banks hold their foreign exchange reserves in the U. S. dollars. This means that the demand for dollars in the world is extremely high, and because of this, the exchange rate of the U.S. currency is high.

Briefly, the story is that in 1970 there was an agreement that the U.S. dollar is the only currency to buy and sell crude oil, and since then the monopoly on all oil trade slowly but surely made the U.S. dollar’s reserve the currency for global trade in most goods and raw materials. Huge demand for the dollar began to push its price higher and higher. In addition, countries have stocked their savings of dollars in U.S. Treasuries, giving the U.S. government a large pool of credit.

If the U.S. dollar loses its position as the world’s reserve currency, the consequences for America will simply be shocking. The main part of the dollar’s value is tied to the oil industry – if that monopoly disappears, the value of the dollar will be considerably decreased. The consequences of this shift will be significant, and all of them are difficult to predict, but one thing is certain – the price of gold will begin to grow. Uncertainty around paper money is always a good reason for moving back to gold. This is what the U.S. dollar means for America and for the whole world.

Money is the only thing that can be used for one reason only. People exchange them for something they are interested in. Money does not feed people, it does not dress them, does not give shelter and is not ever entertaining while being not spent or invested. People will do almost anything for money, and money will do almost anything for people.

Money is perhaps one of the most important elements of any economic system that makes it work. The current monetary system works well and smoothly, it provides vitality in all stages of the production process, in circulation of revenues and expenses, promotes the full use of the available production capacity and manpower. Conversely, if a functioning monetary system works poorly, intermittently, then it could be the main reason for the decline or rapid changes in the level of production, employment, rising prices and declining incomes.