Wednesday, 21 July 2010

Money is a store of value

Money is a depreciating store of value during inflation and an appreciating store of value during deflation.

Money has to maintain most of its value over time in order to be accepted as a medium of exchange. It would not solve barter’s double coincidence of wants problem if it could not be stored over time and still remain valuable in exchange.

The fact that inflation is destroying the real value of money means it is a store of depreciating real value during inflation. Money was a store of value right from the start. First types of money consisted of gold or silver coins. The metals from which the coins were made had an actual real value in themselves and these coins could be melted down and the metal could be sold in its bullion form when the bullion price was above the coin price. Next money was not made of precious metal coins but money consisted of bank notes, the real values of which were fully backed by gold reserves. Today depreciating money simply represents depreciating real value since depreciating bank notes and bank coins have no intrinsic value. Although the store of value function and nominal values of depreciating bank notes and bank coins are legally defined, their depreciating real values are determined by the economic process of inflation or deflation.

The abuse of money’s store of value function led to inflation.

Money is very liquid; i.e. it is readily available as cash and it is normally easy to obtain on demand in most economies. A property, e.g. a well-located plot of land with a well-maintained and well-equipped building is also a store of value. It is however quite an illiquid store of value. The real value is not immediately available in easily transportable and divisible cash. Money’s high liquidity makes it more desirable as a store of value in comparison with other stores of value like gold, property, marketable securities, bonds, etc. Money is obviously not the best store of value in an inflationary economy where its real value is being destroyed by inflation. Money is normally available in convenient smaller denominations which facilitate everyday small purchases. As such, money is very user friendly. It is easily transportable especially with electronic transfer facilities.

Inflation actually manifests itself in money’s store of value function since inflation always and everywhere destroys the real value of money. Inflation does not manifest itself in money’s medium of exchange function or unit of account function which vindicates the fact that inflation can only destroy the real value of money and monetary items; i.e. inflation has no effect on the real value of non-monetary items. Money is always a medium of exchange of equal real value at the moment of exchange. Free market prices are adjusted in the market in a price setting process that takes the decreasing real value of money into account (amongst many other factors) so that economic items (the product or service and the amount of money) of equal real value are exchanged at the moment of exchange.
Depreciating money has a constantly decreasing real value. Depreciating “bank money” deposits have the same attributes of depreciating money with the single exception that they are not physical depreciating bank notes and bank coins but accounted depreciating monetary values. The depreciating money represented by depreciating bank money also has a depreciating store of value function.

Kindest regards

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith

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