In this part of the lecture we will introduce some basic definitions

associated to the concept of money and a characterization of

different kinds of money used in the past.
We will also discuss some features of money in contemporary
economies. We will start our basic definitions with the concept of
an asset. An asset is any form of wealth: from real estate to financial
assets, from valuable paintings to jewellery, from cars to cash.
The second important concept is money. We will  define money as the
assets that can be easily used to buy goods and services.
In principle, in contemporary economies we rapidly identify
money with banknotes and coins. Even though the main intuition
of this identification is correct, we will see that money is
more complicated that it would seem. The third important crucial
concept is the one of liquidity. Liquidity is the facility with
which an asset is converted into cash, this is banknotes and coins.
An asset is liquid if it can be converted into cash without a large
to loss of value. For instance, a banknote is extremely liquid because
it is already cash. The balance in a savings accounts are almost as liquid as
a banknote because it is possible to pay with a debit
card in most of the shops or, eventually,
to use it in an cashpoint. But the house or a very rare
and valuable piece of jewellery is not very liquid because it
takes a lot of time and effort to transform it into cash.
We have already defined money as those assets that can be easily
used to buy goods and services. As we will see, many kinds of objects
have been generally accepted for exchange in human history.
Despite this variety, there are three main roles that money
has in a modern exchange economy. First, and related with its
definition, money is a medium of exchange. A medium of exchanged is
kind of asset that people accept with the purpose of using it
in future transactions. So, a medium of exchange must be
generally accepted for trading. Eventually, you can exchange a house
for three cars, or car ride for some quantity of gasoline.
But, neither a house nor car nor gasoline are generally accepted for buying
goods and services. So, they are not mediums of exchange.
Money is also a store of value. Given that transactions
are not simultaneous, durability is a necessary characteristic
of a medium of exchange. When the value of an asset
in the future is not certain, people are reluctant to accept that
asset when selling goods and services. This is why perishable
goods, like an ice-cream, can never be used as medium of exchange.
And this is why, historically, hard materials,
like precious metals, have been used to produce money.
Finally, money is also a unit of account.
It means that all the prices are defined in terms of the monetary
unit. In many countries in Europe all the prices are defined in
euros while in the US they are denominated in dollars.
An interesting example of the role of money as unit of account
is related with the transition in 1999 from
the 'peseta' to the euro in Spain. Immediately after the transition,
some money users, mostly old people, defined all the prices in 'pesetas'
even though the euro was already the official currency.
For them, the 'peseta' was stil the unit of account
but they used the euros as a medium of exchange.
Eventually, with time, everybody got used to the euro and the
'peseta' ceased to be the unit of account. When we think about ancient money,
the reference to gold and silver coins is obvious.
For centuries people thought of money very naturally in terms
of precious metals; this kind of money is called commodity money:
coins had intrinsic value because of their content of gold and
silver but they also have a value because they were a medium
of exchange. In some historical situations
people preferred to melt the coins and use the precious metals
for other uses but, most of the time, they used the coins as money.
The silver coin in the pictures comes from the North of Africa around the
9th century BC. The gold coin is a Persian coin from around
the 5th century BC. More recently, basically in the 19th century
and the first half of the 20th centuries,
most of the money was what we call the commodity-backed money;
commodity backed moneys were composed mainly of banknotes but
that these those were explicitly backed by precious metals stored
in the vault of a bank. The picture shows a one hundred dollars
banknote of 1928 in which the gold certificate explicitly
guarantees that there was a deposit of gold to back the banknote.
However, today, if you look carefully to the banknotes in Europe
or USA you will not find any reference to precious metals.
In fact, they are not backed by precious metals whatsoever.
There is no institution that guarantees that you will receive
some intrinsically valuable thing in exchange for your banknotes.
Then, the question is… Why these pieces of paper are valuable
but these ones are not? The answer is simple: they are valuable
because everybody thinks so. Every person is willing to accept
a dollar or a euro in exchange of good only because she knows
that she can buy another good in exchange of the banknote.
Trust is nowadays the most important basis for the value of
money. This is why our money is called fiduciary money,
from Latin 'fiducia' which means trust,
confidence, reliance. This fiduciary money is also called fiat
money and it has some legal support in the sense that it is considered
'legal tender'. It means that it is valid for meeting
any financial obligation. If you must honour a debt, you can always
use official currency to do so. This characteristic of legal
tender, which is true for most of the currencies worldwide, is
made explicit in current dollars. However, nothing
and nobody guarantees the value of a currency for present and future
transactions. For instance, the periods of rapid increases in prices
in Germany in the 1920s reduced systematically
the value of the German Mark; in those years more and more marks
were needed to buy the same amount of goods and services.
Banknotes of 50 millions of marks were printed.
The value of the mark in terms of gold declined dramatically.
Or what is the same, the price of gold in marks increased enormously.
And not only gold, but any good in the economy.
This process, called hyperinflation, can eventually happen in
any country if the monetary authorities do not act responsibly.
In such cases, those individuals keeping a large quantity
of cash can experience a large loss of value.
Banknotes can lose their functions as store of value and medium
of exchange… German children in the hyperinflation period played
using packs of banknotes as bricks. Hyperinflation is destructive
for an economy as people lose confidence in money, and then
money loses its role. Luckily it a rare phenomenon in modern economies.