There are six characteristics of money that deem a currency well-functioning enough to serve our modern economy:
1. It must be durable enough to withstand the physical wear and tear that comes from being used over and over again.
2. It must be easily transferable from one person to another.
3. The money must be easily divided into smaller denominations.
This allows for people to only use as much money as necessary for any exchange.
4. All units of money must be uniform in terms of what they can purchase; a dollar is a dollar is a dollar.
5. There must be a limited supply of currency to make it of value.
6. Everyone in an economy must be able to exchange the objects that serve as money for goods and services.
If people were to lose confidence in a currency’s value, it would lose its worth.
Commodity money consists of objects that have value in and of themselves, and are thus used as money. Things like salt, cattle, and crops are considered commodity money.
This system of money works well in simple economies, but isn’t portable, durable, or divisible enough for larger economies.
Representative money makes use of objects that have value because the holder can exchange them for something else of value.
Early representative money took the form of paper receipts for gold and silver. Each note held worth because they were backed by the promise of a certain amount of a precious metal that was worth something in itself.
However, these only work as long as the government or bank issuing the representative money has enough of whatever’s backing it to withstand any large-scale conversion demands that may occur.
Fiat money is money that has value because the government has ordered that it’s an acceptable means to pay debts. The United States uses this system today.
The Federal Reserve maintains that there is a limited supply to our legal tender, which also gives it value; without some sort of control of the money supply, the fiat system won’t work.
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