Money affects almost every aspect of people’s lives. It acts as a medium exchange, enabling people to trade. In line with Durani (2), the introduction of money connotes one of humanity’s greatest inventions. Before its invention, trade involved the direct exchange of commodities and services. Today, money acts as an intermediary enabling people to make an indirect trade. There are different types of money, and as long people accept and trust them, they can be used as a medium of exchange. While they perform the same functions, they have several differences. The paper will compare commodity, commercial, fiduciary, and fiat money.
Meaning and Definition
Commodity money is the oldest form of money. It uses natural or physical resources as a unit of account, medium of exchange, and store of value. Examples of this type of this money include silver, copper, and gold coins (Hendrickson, 4). It gains value from the scarcity of these commodities. It traces back to the barter trade system, where people directly exchanged goods with other goods. Commodity money also facilitates this trade process. However, it is imperative to acknowledge that the inherent worth of the commodity defines its value. Unlike the barter system, commodity money functions as a unit of account that enables buyers and sellers to compare the value of their items and services. The commodity becomes money.
On the other hand, fiat money is not backed by the price of commodities like silver or gold. It is established or issued by government regulation (Chen and Anderson). As such, its value depends on the public’s faith and trust in the currency’s issuers, the government, or the central bank. Local banks and other financial institutions sometimes issued the type of money in the past. Today, the form of money relies on the creditworthiness of a nation’s government. As stated by Chen and Anderson, fiat money is not pegged to physical commodities but rather to the virtue of government declaration and faith of its holders. It involves paper money that is mostly used in modern society.
Fiat money is an alternative to barter trade because it serves as a storage medium for purchasing power. In other words, it enables people to purchase goods and services without trading their products or services in exchange. With its ability to store purchasing power, fiat money allows people to establish specialized economic activities and make easy buying plans. For example, it enables businesses to purchase new equipment, recruit workers, compensate them, and open new subsidiaries. Examples of fiat money include bills and coins.
Fiduciary money involves coins and banknotes circulating a country’s economy. It refers to the available liquidity that enables people to carry out transactions. It is a tangible property (Ida et al., 354). King Aliatte II made the first coin in 650 BC to avoid recording all transactions between economic agents by hand. With time, all geographical areas worldwide created their currency, promoting trade. Therefore, it is beyond reasonable doubt that the invention of money eliminated the barter system, thus improving trade.
Unlike fiat money, fiduciary money is not a government-issued currency. In other words, citizens are not mandated by law to agree or receive it as a form of payment. It is upon the issuer of the money to decide whether or not to accept to exchange it for fiat money or a commodity upon the bearer’s request. It is a promise between the payer and payee (CEOpedia Management). People use it just like commodity or fiat money as long as they believe transacting parties will not break the promise. It is paid in paper money, silver, or gold. With that said, the current monetary system uses fiduciary money in various ways. For example, when banks promise to pay clients for different types of money, the customer can transfer or sell the agreement to someone else. This form of arrangement is referred to as fiduciary money. Examples of the type of money include drafts, banknotes, and cheques.
Notably, commercial money refers to claims against monetary institutions like banks that can be utilized to buy products and services. Commercial banks create it through fractional reserve banking. Durani (4) defines fractional reserve banking as a procedure whereby commercial banks lend out money in the form of loans that are more valuable than the actual base of the currency they hold. The loans can be up to ten times more valuable than the actual currency.
Commercial money is debt that can be exchanged for money. When commercial banks create account balances and give out more valuable loans, they lend out money that they do not have. The type of money is made in scriptural money, where banks claim debt from borrowers and account holders claim debts from the bank. Compelling evidence has shown that it makes up the highest percentage of money in circulation in the economy (Bossone). Most people deposit their money to commercial banks, and these institutions give them out as loans. Commercial money is also referred to as bank credit, term deposits, bank liabilities, time deposits, and demand deposits.
Another difference between fiat, commercial, fiduciary, and commodity money is the source of their value. In line with this statement, the value of fiat money comes from the legally-decreed monopoly state of power. It comes from a government order that mandates the use of the currency as a legal tender in a country. The government declares this type of money as a legal tender, requiring all people and businesses in the nation or region to accept and recognize it as a means of payment. Failure to accept it can lead to imprisonment and fines. As articulated by Bawono and Prestianawati (16), the intrinsic value of fiat money is lower than its face value. In line with this statement, the relationship between supply and demand determines its value. Most contemporary economies, including the US, use fiat money.
The value of fiat money also depends on a given country’s governance and economic performance. It also relies on how these factors affect interest rates. For example, political instability weakens a nation’s currency, leading to inflated prices of goods and services, making it difficult for people to purchase products they may need. On the other hand, fiat money has more value when the public trusts it to act as a storage medium for purchasing power. It also functions well when fully backed by the government’s creditworthiness that issues, decrees, and prints it as a legal tender for monetary transactions. It is vital to acknowledge that fiat money has no intrinsic value and thus depends on trust from the public and confidence in the issuing government. Such means that it can be replaced by the central bank or the Federal Reserve Bank.
The value of fiduciary money depends on the production costs of coins and banknotes. According to CEOpedia Management, its inherent value is very low. The nominal value fixed at its creations tends to be higher than its intrinsic value. It functions well depending on the confidence that economic agents place in it. Coins and banknotes have a legal value guaranteed by the central bank and the state. It is also shown on the financial instrument. If economic actors lose faith in these institutions, fiduciary money loses value. In other words, its value comes from the trust declared by the state. The type of money functions well if it is widely accepted as a medium of exchange. Like fiat money, fiduciary money is essentially worthless on its own. Its value comes from being able to exchange it for something else.
On the other hand, the trust of commercial money comes from commercial banks that give out loans and depositors who store their money in these institutions. The banks and depositors believe that their money will still have value when they get it. The government or the central bank does not create commercial capital. It is made by high-street, private commercial banks in lending out money (Gross and Siebenbrunner). The money is mostly in electronic form. Before the invention of computers, financial institutions would still create money by adding deposits to their balance sheets. As previously discussed, commercial money is made using clients’ fiat money. After customers deposit money in commercial banks, only a specific percentage is held within the institutions. They give out the other percent to others in the form of loans, enabling them to make more money from fees and interest charges. Therefore, the value of commercial funds depends on the trust that both the depositors and banks will get back their money, and it will still have value in it.
Unlike other types of money, commodity value has store value. Even if it is no longer used as a form of money, it has value because it is physical. People can see and touch a commodity. The other types of money solely rely on the trust of their value. They cannot be seen or touched. The underlying value of commodity money enables people to build confidence in it. In line with this statement, commodities like tobacco and gold have other uses than a medium of exchange. If one business rejects them, the resources will be valuable somewhere else. Unlike the other forms of money, commodity money has an intrinsic value (Bernholz, 20). It is worth something other than its use as a medium of exchange. For example, people can use tobacco as a medium of exchange but can also use it to make cigarettes. Therefore, commodity money has actual value due to its various utility, making it a more acceptable medium of exchange. Commodity money has inherent value, which cannot be replaced by the central bank or Federal Reserve Bank.
Bankov (340) defines legal tender as any currency recognized by the government as a means of payment. It is money declared legal by the rule of the land. In line with this statement, fiat money is government-issued currency. The authority of national governments backs it. Therefore, it is legal tender. On the other hand, the value of fiduciary money depends on trust between the payee and payee. For example, cheques are accepted as a medium of exchange based on trust, not the government’s order. Hence, fiduciary money is not legal tender. People do not have to accept it. Similarly, commercial money is not backed by the authority of the government. While it is highly used to represent base money in financial transactions, it is not legal tender. Commodity money is also not backed by the government.
Fiat money allows the government to control the economy by deciding how much money is printed or created. However, this feature makes it more susceptible to inflation. If central banks create too much fiat currency, they increase the risk of inflation (Durani, 9). When the money supply is excess, governments can cause hyperinflation. As previously discussed, fiat money is not associated with physical commodities, and thus, has a higher risk of losing value in the event of inflation. The currency can also become worthless during hyperinflation. In the same way, lack of public faith in a country’s currency contributes to loss of value. Unlike commodity money, fiat money is also irredeemable.
On the contrary, money backed by physical commodities is at a lower risk of devaluing from inflation. Such is because resources have intrinsic value. For example, gold can still be used to decorate, make jewelry, and manufacture electronic devices. Moreover, the government cannot create more physical resources, preventing them from making more money whenever they want to. On the other hand, inflation also affects the creation of commercial funds. It forces banks to increase their interest rates, leading to an influx of less credit-worthy borrowers.
Medium Of Exchange
Fiat, commercial, commodity, and fiduciary money have some similarities. Initially, they all function act as a medium of exchange. It enables people to exchange it for the services and goods they need. As stated by Korobeynikova, Mikhailovna, and Korobeynikov (92), money allows individuals to purchase what they need easily. It acts as an intermediary instrument. Without it, people would still be using a barter system, where people exchange a product with another. The trading system is only effective if there is a double coincidence of wants. In other words, barter trade is only effective if both parties have what the other desires. It creates more problems when an individual does not have goods that measure up to the value of the other person’s products.
Common Measure of Value
Concurrently, the four types of money serve as a unit of account. They enable people to measure the value of goods and services. They are consistent, allowing people to compare the worth of a $5 beverage and a $100 table. Without money, people could be paying for these products with other goods, making it harder to understand their value. Therefore, the four types of money function as a common measure of value, allowing buyers and sellers to quote, compare, and bargain prices.
Store and Transfer of Value
In like manner, the four types of money act as a store of value. They retain their worth over time. They can be stored, saved, and retrieved while still a reliable and viable medium of exchange (Vaza, Milneb, and Browna, 16). From a liberal point of view, if one sold furniture for fruits, it would be difficult to increase wealth because fruits are perishable. They will become worthless within a short period. Therefore, the four types of money act as a store of value because they are durable, enabling people to continue increasing their wealth.
They act as a store of purchasing power, allowing people to hold it over a long period and finance future payments. However, the types of money retain value in the absence of severe inflation. They also act as a transfer of value. People can use them to purchase goods and services beyond their domestic territory. They act as a standard tool that enables individuals to sell or buy goods locally and internationally. Hence, the four types of money function as a store and transfer of value.
The types of money are also acceptable to make purchases that will be paid in the future. They act as a store of value and are accepted as a medium of exchanges, making them vital for transferring value for trade at different times through loans, debt, credit, and future agreements. For example, if one borrows a specific amount of money from another person, they repay it with interest. Such refers to deferred payments.
In conclusion, commodity, commercial, fiduciary, and commodity money have differences and similarities. Commodity money depends on the intrinsic value of physical resources that serve as a medium of exchange. Fiduciary money functions well when widely accepted as a medium of exchange. Fiat money derives its value from the government’s decree and authority. The value of commercial money depends on the trust of depositors and the banks. Fiat money is the only type of money that is legal tender. Commodity, commercial, and fiduciary money are not government-issued currencies. However, the four types of money serve as an intermediary trade instrument, store and transfer of value, standard deferred payment, and measure of value.
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