Money and currency are often interchanged and used loosely. But what is money and what is currency? What are the differences between money and currency?
If you were asked, “how much money does it take to buy a car” your typical answer would be, “You can buy the car for $50,000”
What you mean by that is that you value your car at 50,000 US dollars. What if the buyer was from Germany? Your German customer will still pay you 50,000 US dollars, but in effect he is paying you €45,454 (at a EURUSD exchange rate of $1.10, or where 1 US dollar is equal to 1.10 euro).
As you can see, the money value remains the same, but the currency value changes. Money is therefore a store of value, currency is a form of exchanging this value.
What is money?
Money is a term that is loosely used and is often interchanged with currency. It is perhaps this very reason that people often mistake money as that hard currency you/we love to have with us. But money is different from currency.
Money is defined as a medium of exchange and a store of value.
Today, this medium of exchange is in the form of coins or banknotes, also known as currency. Currency is a convenient way or a medium to exchange goods and services.
Prior to currency, people used to barter to get/offer services. The barter did not however provide transferability or divisibility. For example, if you bartered your radio to your maid to get your 6-room house cleaned and the maid now wants to buy a loaf of bread, the radio cannot be broken into two. In other words, under the barter system, it is difficult to divide, unless the services are seemed to be equal. Secondly, what if the shopkeeper believes that the Radio is actually worth only two eggs?
While money is a store of value, how can you exchange this? Enter currency!
What is currency?
Currency is defined as a system of money in general use.
Currency is a form of physical representation of value that changes over time. Currency is a type of money, just as Gold or Silver is, or even jelly beans if you’d like. Banks can create more money by means of fractional reserve banking or by simply entering numbers in a ledger, but they can never create currencies. Currency is the sole bastion of a central bank.
With currency, the maid is now paid $60 to clean 6 rooms. The maid can now pay $2 to buy eggs. The shopkeeper sells two eggs for $2.
If four people agree to use beans as a store of value, it becomes money. They can now pay each other in beans for exchange for goods or services. The beans now hold value as currency and remain in value as long as the four people see value in it.
Money and currency have similar characteristics.
- Money and currency can be interchangeable
- Money and currency is fungible (1 US dollar is the same, either in the US or in Australia)
- Money and currency can be divisible (you can make change)
- Money and currency is portable (you can carry $1 in your pocket, or a gold coin)
- Money is a store of value, currency is not
Why can’t we use Gold or silver as money? (Inflation & Deflation)
Gold and silver was at one point in time in history used a form of money. It had a store of value and at a certain point it was easy to carry gold and silver coins around. However, gold and silver came with a big limitation, which is, they are limited in supply and this has wider implications on the economy. Limited money supply, although advocated to be a good thing can be debilitating effects when people stop or reduce their buying/spending or lending behavior.
Let’s take a simple example of a shoe seller in a world that deals with gold and silver.
The businessman wants more money (gold or silver) so he can buy a car. If for whatever reasons, his customers stopped coming, he would have to lower the price of the shoes that he sells. In other words, the price of his shoes has fallen in value. When this happen on a large scale, it is known as deflation. Due to the limited supply of gold and silver, it is hard to pump extra money into the economy.
As a result, the businessman has to put off his plans of buying a car. Lesser people start buying cars, which has an impact on the car dealer. Lesser sales result in smaller manufacturing. Smaller manufacturing leads to job cuts. No jobs means, no money to pay or afford things.
Fiat money or paper money addresses this very specific aspect and maintains a fine balance between supply and demand. It is the role of a central bank to therefore determine when to print more money (currency) and when to stop. This is also known as monetary conditions or monetary loosening or tightening. In a deflationary environment, the central bank has the ability to pump money into the economy.
Therefore, now the shoe seller can get a loan and buy a car. The car dealer now has customers, more customers means manufacturing goes on full steam, which means the workers get paid.
However, when a central bank prints too much money, the shoe seller and the car dealer can take out more loans. When the supply of money increases, prices of goods also increase, because now there is more money. This is an inflationary environment which if goes unchecked can result in hyper inflation where eventually, the trust in money starts to fade.
A good example of hyper inflation is the case of Zimbabwe, which at one point had to print $100 trillion Zimbabwean dollars. The full case study of this hyper inflation can be read here. The hyperinflation ended only after the country swapped out its currency for the US dollar and the South African rand (which pushed the country from hyper inflation and straight to deflation).
Besides explaining inflation and deflation, the above example also shows the difference between money and currency. The value of a loaf of bread produced in Zimbabwe didn’t change, just the currency that depicted the value. While the Zimbabwe dollar did not have a large store of value, the US dollar did.
So the next time someone asks how much money does it take to buy a car, or how much money you make a year, remember that when you answer the question, you are simply expressing the value in terms of currency.