What Money Is
Money is not wealth. Money is a tool for moving wealth around.
If you were stranded on a desert island with a suitcase full of cash, you would starve. The real wealth there would be food, shelter, tools, and knowledge - the things that keep you alive and comfortable. Money is just the claim check that lets you collect some of those things from other people.
Money serves three functions:
- Medium of exchange - you do not have to barter your labor directly for bread. You work for money, then spend money on bread.This is the problem money solves - not needing to find someone who has what you want, and who at the same time wants what you have.
- Unit of account - prices are expressed in money, giving you a common measure to compare the value of different things.
- Store of value - money holds its value (mostly) over time, so you can earn it today and spend it tomorrow.
DADPHIS - The Seven Attributes of Useful Money
For something to serve these functions well, it needs seven attributes. The mnemonic is DADPHIS:
| Attribute | Meaning | Good Example | Bad Example |
|---|---|---|---|
| Durable | Does not rot or degrade | Gold | Fish |
| Acceptable | Everyone agrees to take it | Dollars | Beanie Babies |
| Divisible | Can be split into small units | Digital currency | A cow |
| Portable | Easy to carry around | A banknote | Gold bars |
| Homogeneous | One unit is the same as another | A dollar bill | Diamonds (all different) |
| Identifiable | You can tell real from fake | A modern banknote | Cowrie shells |
| Scarce | Cannot be created at will | Bitcoin (fixed supply) | Seashells on a beach |
The last one - scarce - is the one most often forgotten. Throughout history, governments have discovered that the easiest way to finance their spending is to create more money. And every time they do, the money loses value. The other six attributes are useless if the money is not reasonably scarce.
Fiat Money
Most money in the modern world is fiat money - it has no intrinsic value. A $20 bill costs a few cents to print. It is valuable because the government accepts it for taxes (creating demand), and because everyone else accepts it too (creating confidence).
Fiat money has many advantages over commodity money (gold, silver). It is easier to transport, harder to counterfeit, and the supply can be managed to stabilise the economy. But the same flexibility that makes it useful also makes it vulnerable: a government that prints too much destroys its value through inflation.
Common Misunderstandings
Money is not the same as wealth. This is the single most important thing to understand. Confusing the two leads to policies that protect “the money” (tariffs, capital controls) at the expense of the real wealth (goods, services, productive capacity).
The total amount of money in existence is not fixed. Most money is created by banks when they make loans, and destroyed when loans are repaid. A growing money supply is normal in a growing economy. The problem is when it grows faster than the economy’s ability to produce real goods and services.
See also: Prices, Interest Rates, Macroeconomics