What is money?

April 25th, 2008

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This is a deceptively simple question. Last time, money was simply gold and silver. But today, in this modern age of finance, money is far more complicated than what it was used to be. It has come to the point that it is very hard to even define what money is, let alone measure its quantity. Alan Greenspan, the former head of the US Federal Reserve was believed to have said ?We don?t know what money is, any more.? Today, we will explain what money is by explaining the various measures of money supply, according to the definitions of Australia’s central bank, the Reserve Bank of Australia (RBA).

A good way to see money is to think of it as an inverted pyramid, the apex of which is the most liquid form (and most favoured by drug dealers). This most liquid form of money is defined as currency. Currency is the (1) physical notes and coins that can be seen, touched and smelled and (2) held by the “private non-bank sector” (which is basically institutions, companies and individuals that are not banks and governments). Currency is mentioned in the graph in our previous article, Australia?s monetary debasement & credit expansion.

The next broader measure of money is the monetary base, which is (1) physical notes and coins held by the “private sector” (which is anything that is not of the government), (2) banks’ deposit at the RBA and (3) what the RBA owes to the “private non-bank sector.” The central bank (RBA) is the bank of the government and banks. Therefore, your bank will have an account at the RBA where it keeps its money, which is the previously mentioned (2). For (3), an example would be the Medicare rebate that you receive from the Australian Commonwealth government. It will come in the form of a cheque drawn from the RBA. The difference between component (1) of currency and component (1) of monetary base is that the former excludes physical money held by banks (e.g. notes stored inside the ATM machines).

The next measure of money is M1. It is comprised of (1) currency and (2) bank current deposit held by the “private non-bank sector.” In Australia, you may have a current deposit account that pays almost no interest and you can withdraw your money from it at any time. This money will be included in M1.

The next broader measure of money is the M3. It comprised of (1) M1 and (2) other deposits with bank (e.g. term deposits, certificates of deposits, etc).

The broadest measure of money is broad money, which comprised of (1) M3 and (2) borrowings of financial institutions from the private sector. Your money kept in high-yield cash management accounts will be part of broad money.

So, how can there be so many measures of money, from the most limited currency (AU$39.4 billion as at February 2008) to massive broad money (AU$ 1074.5 billion as at February 2008)? Well, you may want to read our earlier article, 363 tons of US dollars to Iraq?how much money will eventually be multiplied into the economy?.

Next article, we will show you an updated graph of Australia’s money supply.

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