Properties of good money

February 25th, 2008

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Previously, in Is gold an investment?, we mentioned that we will talk about silver in the next article. However, we feel that we have to explain one more important point first before we can move on to silver. Please forgive us…

Remember, in A brief history of money and its breakdown- Part 1, we explained how money developed,

At this third stage of monetary development, a highly marketable good will eventually emerge as the most sought-after intermediate good for the purpose of exchange with other goods. This intermediate good functions as money as we know it. Obviously, such an intermediate good must have characteristics of portability, divisibility, durability and sufficiently rare (but not too rare).

Over the course of time, many commodities (e.g. tobacco, cattle, grain, cooper, seashells and tea) at one time or another functioned as money. But eventually, gold and silver became money for most civilisations and societies in history. Obviously, many of the commodities were eliminated from being money. So, the next question to ask is, what makes a commodity ideal to function as money? They are:

Ideal money must be portable. That is, it has to be convenient for you to bring it along to wherever you want. Obviously, cattle fail the portability test and was not the favoured form of money.

Ideally, money should be easily divisible to cater for all types and sizes of transactions. Again, cattle obviously fail the divisibility test.

Physical money should be durable. If not (i.e. can decay), it cannot be a reliable store of value. Tea fails the durability test.

Sufficiently rare
Obviously, money has to be sufficiently rare. If not, you will have to haul a massive quantity of it for transactions. Seashells fail this test. On the other hand, it cannot be too rare. Otherwise, it will be impossible to sub-divide it further for tiny transactions.

Any commodity that functions as money ought to be fungible. That is, you can trade or substitute it for equal amounts of like commodity. Someone asked whether diamonds is a suitable commodity for money. The answer is no because diamonds are not fungible. Since each diamond is unique, they cannot be substituted or traded easily. Therefore, it cannot be conveniently used for transactions.

Oil cannot function as money because because it is a consumable commodity. Obviously, it is not a good idea to consume your money! It’s pragmatic value is far too great to function as money.