The Monetary System, Money Is Not That Amazing

Central Banks and the Monetary System

Ever since the central banks, especially the Federal Reserves (Fed), bailed out corporations and banks all over the world, people have tried to figure out if they were screwed in the process. Many individuals throughout the media and political system have their own definitions of the central bank and its monetary policies to promote their point of view for selfish purposes.

From an economist's point of view, the duties and effects of central banks on the economy are still confounded by the variables introduced into this new era. However, economists use data and approach the system from a more scientific perspective.

It is essential that the individual understands the monetary system before probing further into the Federal Reserves and its Federal Open Market Committee.

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Let us began by looking into the monetary system

A. Double Coincidence of Wants

1. Barter system- there is a small possibility that 2 people will end up trading exactly what they wanted to trade. As a result, people came up a medium of exchange.



B. Money- The set of assets that people regularly use to buy goods and services from other people.

1. A medium of exchange- Money is an item that buyers give to sellers when they want to purchase goods or services.
a. Like in the barter system, but people will use the medium as the good used in the trade.

2. A unit of account- Money is a yardstick for prices and debts.

3. A store of value- Item that people can use to transfer purchasing power from the present to the future.
a. Money holds purchasing power as long as people accept it.



C. Liquidity- Ease of which an asset can be converted into the economy’s medium of exchange.

1. Money is the most liquid asset as possible. Meaning that at any time, people will accept it for goods and services assuming that a sufficient amount is given.

2. Money is not a perfect storage of value as its value is determined by what people want it to be. Gold on the other hand, is relatively perfect at storing value.

3. Determining what asset to hold- People compare the liquidity of the asset that they acquire to the store of value.
a. Gold may be recession proof, but it is not easy to move around and be used as a medium of exchange.
b. Money can be very liquid, but inflation can screw it up.



D. Fiat Money and Commodity Money

1. Fiat Money has no intrinsic value
a. There are expectations and social conventions involved.

2. Commodity money has intrinsic value
a. Like gold, or cigarettes during WWII. Even people who didn’t smoke accepted cigarettes.
b. People were confident that these products can act as “money” and can “store value” and has purchasing power in the future.



E. Currency

1. Money Stock- Quantity of money circulating in the economy.

2. Currency is paper bills and coins released to the public.

3. Demand deposit- Balances in bank accounts that depositors can access on demand simply by writing a check.
a. Money in savings accounts is not part of the money stock.
b. Money in checking and mutual funds are part of the money stock.



F. What is money and what is not money.

1. M1 measurement- Currently $2 Trillion
a. Demand deposits (checking account), traveler’s checks, currency (cash), and checkable deposits.

2. M2 Measurement- Currently $9 Trillion
a. M1 + Savings deposits, small time deposits, money market mutual funds, others.

3. Credit cards are a form of deferring payment and is not part of the measurement.




This is what we have learned so far.
Money is simply a "Medium of Exchange."

Money was introduced for our convenience.

The next part I will talk about the Central Banks and their Monetary Policy.