Types of Money: Fiat, Commodity & Commercial Bank Money

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Commodity money has been used throughout history as a medium of economic exchange. Commodity money is money that has intrinsic value, meaning that it has value even if it is not used as money. Examples of commodity money include precious metals, foodstuffs, and LINK even cigarettes. So does all this mean that commodity-backed digital money — stablecoins backed by gold — will replace fiat currencies across the world?

• Inflation measures the rate at which the average price levels in an economy increase over time.
• In times of economic turmoil, more people would rather accept commodity money instead of government-issued money.
• If this persists, the government may decide to withdraw that unit of currency from circulation.
• During this period, Lydian merchants produced a gold coin mixed with silver; otherwise known as electrum.

He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem. Currency itself is perfectly liquid; you can always change two $5 bills for a $10 bill.

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Between 1933 and 1970 (when the U.S. officially left the gold standard), one U.S. dollar was technically worth exactly 1/35 of a troy ounce of gold. Fiat money like the US dollar seen in Figure 2 is a medium of exchange that is backed by the government and nothing else. Its value is derived from its official recognition as a medium of exchange from government decree. Unlike commodity and representative money, fiat money is not backed by other commodities such as silver or gold, but its creditworthiness comes from the government recognizing it as money. This then brings all the functions and characteristics that money has.

They are all characterized as having intrinsic value, which is found in their utility beyond means of exchange. This was because, for a time, the supply was self-regulating. That is to say, farmers would produce large quantitates of tobacco, but the population would consume in equal size. Nevertheless, there was a fundamental issue in the fact that the supply would eventually outstrip the demand; meaning there was a large supply of tobacco and/or salt. As it was a form of money, this inevitably led to inflation.

Examples of Commodity Money

Money differs from these other stores of value by being readily exchangeable for other commodities. Its role as a medium of exchange makes it a convenient store of value. We use money in this fashion because it is also a medium of exchange. When we report the value of a good or service in units of money, we are reporting what another person is likely to have to pay to obtain that good or service. Cigarettes may be used as a form of commodity money in some circumstances. Paper money is not commodity money because it has relatively little actual worth on its own.

By contrast, fiat money only has value that is guaranteed by government. For instance, if the US government said it was no longer using the dollar, a 1 dollar bill would become worthless. The disadvantages of commodity money led to the rise of another type of money known as Fiat money. Fiat money is the type of money that is issued and regulated by the government.

The value of this commidity money is directly linked to the value of the asset that is backing the money. The additional $900 has been generated as debt by the bank and reflects commercial bank money. Representative money is a type of money that is issued by the government and backed by commodities such as precious metals like gold or silver. Economies relying on bartering usually evolve to identify something that can be used as a median of exchange. Normally it is a commodity which has sufficient demand that traders know that even if they do not have a use for the commodity, they can easily trade it for something useful.

• A key feature of commodity money is that the value is directly perceived by its users, who recognize the utility or beauty of the tokens as goods in themselves.
• Radford documented the way that this ‘cigarette currency’ was subject to Gresham’s law, inflation, and especially deflation.
• Examples of this include gold like the one in Figure 1 and silver.
• Holders of fiduciary money use it to make payments at later dates.
• We can expect to see this partly as confidence in these currencies falls in the wake of stimulus packages designed to pump money into the economy.

Who says that the dollar you have in your pocket is valuable? You will know a lot more about these questions after reading our article on the types of money. See if you can define and provide examples of commodity money after perusing the lesson above. People have accepted cigarettes and tobacco in lieu of money as a form of payment.

Fiat Currency and Inflation

To see this in action, sadly, it’s only necessary to look at the news. The Covid-19 pandemic has thrown millions of people out of work and blown holes in projected GDP across the developed and developing world. Commodity money is very hard to divide or split into smaller portions per one’s needs.

This is money that only contains any value because the government decrees it has the full faith and credit of the nation backing it. It XLM works because members of society and businesses choose to accept it as their primary form of currency and means of exchanging goods and services. M2 aggregates include all the money supply M1 covers and add some other assets such as saving accounts and time deposits. Commercial bank money helps create liquidity and funds in an economy. Other examples of goods that have been used as commodity money include copper, corns, tea, shells, cigarettes, wine, etc. Several forms of commodity money were employed relative to the needs that certain economic circumstances created.

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Instead, what’s more likely to happen is that the mainstream https://www.beaxy.com/ will find space for both to co-exist. The easy spendability of cash and the extent financial system for processing payments in fiat currency will militate for its retention; so will the conservatism of some institutions and payees. The simple model, however, allows no alternatives to fiat money – fiat money is used in exchange because there is no other way to trade what one has for what one wants. The model has only a single type of good in every period, so trading goods for goods is ruled out.

The lower the reserve requirement ratio, the more funds will be loaned to other people, creating commercial bank money. The value of fiat money is based largely on public faith in the issuer. Commodity money’s value, on the other hand, is based on the material it was manufactured with, such as gold or silver. Fiat money, therefore, does not have intrinsic value, while commodity money often does. Changes in public confidence in a government issuing fiat money may be enough to make the fiat currency worthless.

Fractures in international structures such as the European Union make it impossible to ignore the fragility of the international financial system. However, the virus has brought to the surface these deeper issues and will remain a source of economic anxiety in its own right until decisive medical measures are available. By the 1700s, a new form of money began to emerge in Europe, spearheaded by the use of promissory notes, or notes of hand, among gentlemen.

The conventional dichotomy of “commodity” and “fiat” base monies overlooks a third possibility that shares some features of each. This third type, which I call “synthetic commodity money,” resembles fiat money in having no nonmonetary value; but it resembles commodity money in being not just contingently but absolutely scarce. There are several forms of money which have been used throughout history. The oldest and best proven form is known as commodity money. A form of money invented in the past century which has become the major competitor to this historical currency is called fiat money. A newer post-modern technologically advanced form of spending power is today’s electronic money.