This is post #3 in my series on money and Bitcoin. You can jump to the posts with these links:
- What is Money
- How Money Solves a Problem
- Five Characteristics of Money
- Three Functions of Money
- Money Rankings on a Quality Scale
- How Governments Control Money
I’ve made the point that money is a tool. It is a technology. It was invented to solve a problem.
Every tool has a level of quality. In the world of hand tools, Snap-on tools are better than Craftsman which are better than Harbor Freight. In the same way, different forms of money have different levels of quality.
We can gauge tool quality in several categories. With hand tools, categories could include physical materials (stainless vs. aluminum), production method (stamped vs. die cast), ergonomics, warranty (lifetime vs. shorter), etc. Money also has natural categories within which we can gauge its quality. I’m calling these the five characteristics of money.
Durability
Money’s durability ensures that it can withstand physical wear and tear. Whether paper currency or digital transactions, money must remain functional over time. Imagine a $100 bill disintegrating after a few uses – it wouldn’t serve its purpose effectively.
Examples:
- Coins: Metal coins (like quarters, dimes, and pennies) are durable and can circulate for decades without significant damage.
- Polymer Banknotes: Countries like Australia and Canada use polymer-based banknotes that resist tearing, water damage, and fading.
Portability
Money’s portability refers to its ease of transport. Whether you’re carrying cash in your wallet or making digital payments via a smartphone, portability allows for seamless transactions. Imagine if money were heavy and cumbersome – it would hinder everyday exchanges. It must be easy to carry and transfer, allowing for convenient transactions anytime, anywhere.
Examples:
- Digital Wallets: Apps like Apple Pay, Google Pay, and PayPal enable seamless digital transactions using smartphones.
- Cryptocurrencies: Bitcoin and other cryptocurrencies are highly portable, as they exist purely in digital form and can be transferred globally.
Divisibility
Money should be divisible into smaller units. Imagine trying to buy a small item with a large bill – divisibility ensures that we can break down money into smaller denominations for precise exchanges. Whether it’s splitting a restaurant bill or buying a snack, divisible money makes life easier.
Examples:
- Decimal Currency: Most modern currencies (e.g., US dollars, euros) follow a decimal system, allowing easy division into cents or pence.
- Bitcoin Satoshis: Bitcoin can be divided into smaller units called satoshis (0.00000001 BTC), making it suitable for microtransactions.
Acceptability
For money to serve its purpose, it must be widely accepted. People and businesses should recognize it as a legitimate medium of exchange. Without acceptability, money loses its value – imagine a currency that nobody trusts or acknowledges. Money must be widely accepted by people, businesses, and institutions.
Examples:
- US Dollar: The US dollar is accepted globally for trade, investment, and tourism due to its widespread recognition.
- Euro: Used across 19 European Union countries, the euro enjoys broad acceptability within the Eurozone.
- Argentine Peso: Few people, if any, use the Argentine Peso outside of Argentina. Because of this, and other reasons, it is a lower-quality money.
Scarcity
Limited supply is crucial for maintaining the value of money. This is often called the “hardness” of money. Money is “hard” if it is difficult to increase its supply and “soft” if it is easy.
If money were abundant, its purchasing power would decrease. Scarcity ensures that money remains valuable.
Examples:
- Gold: Historically, gold served as money due to its scarcity. Even today, gold remains valuable and is traded globally. Various estimates are that gold’s annual supply has increased by 1.5%-3% over the last 100 years.
- The US Dollar: Between Jan 2020 and May 2024, the M2 money supply has increased from $15.4T to $20.8T — a whopping 25%1. Is it a surprise that inflation figures have skyrocketed over this same period?
Summary
Like any tool, different forms of money have different degrees of quality. The five characteristics of money provide a decent framework for evaluating various forms of money.
We would expect the best money to rank highest in many or all of these five categories.
Future posts will look closer at the three functions of money, what makes for high-quality money, how various forms of money compare on the quality scale, and more.
1 https://fred.stlouisfed.org/series/WM2NS
This is post #3 in my series on money and Bitcoin. You can jump to the other posts here: