Fact be stated, money is so important in our lives, yet people spend little or no time actually talking about it. What if we are doing many things wrong? What if accurate knowledge about money could help us improve? What if good money knowledge will save us many stress? What if the understanding of how money really works can show that we have been doing many things wrong all along? What if we realise along the line that we don't need to work such long hours to make a living?
- Money!
WHAT IS MONEY?
When you ask a layman that question, mind quickly goes to the currency notes he's holding or in his pocket. Is that all about money?
Money is defined simply a medium of exchange that is being used to purchase goods and services. It is also regarded by its ability to act as a store of value.
Got it? 2 things define money: A medium of exchange, and ability to act as store of value.
Anything in your possession that can perform those 2 roles is what? MONEY!
WHAT CHARACTERISES MONEY?
I mean what are the characteristics of money? There are 3 major characteristics of money, and please note that these characteristics are what determine its value. They are:
1. Its Legal Status: – This is implied by if a society has recognised and accepted the asset as having monetary value
2. Its Accepted Value: – That is if it is widely agreed upon that this asset has a standardised price that can be exchanged for other goods and services
3. Its Scarcity: – That is if supply is controlled and regulated, and its demand monitored.
Anything regarded as money must have in one way or the other the above 3 characteristics. This is not limited to paper money, as we shall see shortly.
TYPES OF MONEY
Now let's talk about types of money that exist. There are 4 major types, for the sake of this discussion, of money that there is. And they ate: fiat, commodity, fiduciary and commercial bank money.
Lets take them one after another so as to explain what they mean, hoping this know can help us handle that paper in our pocket better.
1. FIAT MONEY
Fiat, derived from the Latin word fiat, meaning 'backed by Authority.' Fiat money translates to the notes and coins backed by a government, or authority of the land, so to say. Examples are the Nigerian Naira, Ghana Cedis, US Dollars, British Pounds and Chinese Yuan.
Critical knowledge: it is important to note that fiat money is a currency that is not backed by a commodity or physical good, but rather the value is determined by strength of the issuing body.
The value of fiat money comes from market supply and demand, which usually fluctuates in line with the perceived health of the economy, ultimately determinable by the authority behind it. For example, the Nigerian Naira exchanges official to the US Dollar today at N805 to Dollar. This is determined by 1. The backing authority, Federal Government and CBN, and 2. The perceived health of the Nigerian economy. Take a look at how the Nigerian Naira is currently fairing, as compared with other common currencies even in Africa, using the US Dollar as yardstick:
Fiat money is commonly regarded as LEGAL TENDER and has a floating value, which is determined by the strength of one currency against another in the open market. Fiat money is traded in what’s known as the FOREX (foreign exchange) market, or forex market.
See Exchange rates in mage above.
2. COMMODITY MONEY
This refers to a good that has agreed value. For example Gold. In history, the gold has been adopted as standard of reference for some time. Commodity money is a physical asset that has an intrinsic value. This system is associated with trade by barter, where there is no standardised or agreed-upon medium of exchange. Commodity money is widely used to refer to precious metals, such as gold, which historically backed most global currencies. But in some societies, grains and coffee have also been used.
The Gold Standard Example
A common example of commodity money is the gold standard, which was a monetary system that pegged the value of a country’s currency to a specific amount of gold. It was originally set out to stabilise the prices of global currencies because most paper money was backed by gold held in bank reserves.
Adoption: The United Kingdom adopted the gold standard in 1812, while the US, Germany and France followed suit in the 1870s.
Dumped: The Gold standard was later dumped by these nations due to its limitations as it limits how easily nations and financial institutions respond to economic changes and market events in the modern age. Ad of date, no nation uses the gold standard anymore, fiat currencies have been used in its place.
3. FIDUCIARY MONEY
Fiduciary money is promissory in nature. It is also called future money. Examples of fiduciary money include paper cheques, banknotes, token coins or electronic credit. They tend to have promised future value. It implies a promise of money value at a future date, which is backed by nothing more than trust between the two parties in a transaction.
Fiduciary money has no value until converted into fiat money. For example, if you are issued a cheque of N1 million today, the paper chque has not value until you deposit it into your ba k account and it is converted into fiat money.
4. COMMERCIAL BANK MONEY
This usually symbolises the loans granted by commercial banks to customers. And How's this loan money generated?
From other customers. This is how it works.
When Mr A deposits N10m into Bank B, Bank B can lend out in form of loans say 90% of that deposited money yo needing customers, leaving reference 10% as reserve as mandated by regulations. That N9m is commercial bank money in form of loan given to customer C who wants to buy a truck for his business and wants it financed by a bank. Customer C must now repay the N9m back with interest, while empirically the interest is shared between the bank and customer A who owned the money.
BENEFITS OF THIS KNOWLEDGE?
You sure may have gained one or two facts from the above. But how can this knowledge be useful in real life and practical ways? I'll share two major concepts I can think of. Feel free to comment.
1. STORE OF VALUE. What value?
We have agreed that money is stored of value. What value? When we waste money, we are definitely wasting that value. To understand that value, we need to remember the process of money making. How do you make money? I mean what did it cost you to make that money in your possession?
It costs your time. Your energy. Your resources.
Now, you can agree that you have stored your spent time and resources in the monetary value. If your time, energy and resources are valuable to you, then you must be forced to manage that money well.
2. TIME VALUE OF MONEY
Understanding this concept must make lots of differences in our personal finance life. The time value of money is important because it can help you make decisions about how to best use your hard earned money. Should you invest it, save it, or spend it? By understanding the time value of money, you can make the most informed decision possible.
Do you agree? Feel free to comment.
That's all for now on Azà Hub money matters.
