Money in its transactional, functional role does make the world go round,
and economists are able to tell us how in Economics lesson 101.

The most famous song from the film Cabaret is probably Money Money, performed by Lisa Minelli and Joel Grey. The immortal line that ‘money makes the world go round’ comes from the song. Songwriters John Kander and Fred Ebb compared the difference between life on the breadline and a lifestyle lubricated by money. And arguably they were right, to a degree. Money in its transactional, functional role does make the world go round, and economists are able to tell us how in economics lesson 101. In the economists’ view, money has four key roles. These are the transactional functions of money and are generally considered to comprise a means of:

• Exchange, a replacement for inefficient barter
• Valuation, providing a standard unit for quoting and comparing the value of goods and services
• Deferring payment and calculating and recording debt
• Storing value, allowing wealth to be held and preserved between transactions

Yes, money really does make the world go round, as we all know. The economists have just taken a more formal, academic approach to the matter. Most economists do agree on these four basic roles of money as it applies to us and our households on a day-to-day basis, even if after that disagreement rules. Let’s look at these in turn.

Cash as a means of exchange

One of the driving forces behind the creation of money was to find a more efficient means of exchange than using commodities. Fiat money in the form of notes and coins takes away most of the disadvantages of commodity-based currency when it comes to trade. Now a farmer could sell his pig for twenty-five denarii, and use all the coins to buy a dozen chickens or half of them to buy a sack of grain, now or in the future. Of course, for this to work well, there must be broad acceptance of the practice in the community. Preferably, fiat money should have the backing of a trustworthy ruler or government that aims to protect the value of the coins. This is the role of central banks.

Measurement of financial value

Money is also an efficient means of valuing goods and services. Everything is broken down into a single shared, standard denominator. A coin maintains its value, unlike, say, a chicken whose value is subjective and changes with the age and health of the chicken. In fact, of course, the value of coinage does change over time. Inflation usually is the culprit, although currency debasement also plays its part. However, it’s less erratic than a chicken! With money, it is possible consistently to quote and compare prices for goods and services. Everyone agrees that money is the universal standard and people learn to attribute a common monetary value to their trades.

Deferring payment

Enter the IOU. The IOU is a promise by someone to present another person with goods or payment at a specified time in the future.  However, the recipient of the IOU could trade the IOU to a third party (in exchange for goods or services). This third person could present the IOU to the original issuer at the specified time and, in theory, take possession of the goods or cash instead.

Storing money

Of course, the recipient of the IOU or money does not have to use it immediately. Holding it until such time as it is needed to buy something else is an option. In this case, money has taken on a new role as a store of wealth.

Attributes of money

Anything can be used as money. In prisoner of war camps in the second world war cigarettes were commonly used as currency, a means of exchange for other things needed by prisoners. However, it is received wisdom that, for a currency to work properly, it must be:

• Easily divisible
• Hard to forge
• Easily identifiable
• Transportable
• Durable

Surprisingly, cigarettes do quite well as currency based on these criteria, except, of course, that they are not very durable.

This has been a brief tour of how money makes the world go round. Next month I will start to explore the humanity of money and introduce you to the concept of money as a mirror of the soul.

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This is the first in a series of articles on the roles that money plays in our lives.

Photo by Matthew T Rader on Unsplash

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