Friday, 22 July 2011

Money is an unstable store of value

Money is an unstable store of value

Unstable money is an unstable store of value. Unstable money is a depreciating store of value during inflation and an appreciating store of value during deflation.

Unstable money has to maintain most of its real value over the short term in order to be accepted as an unstable 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 eroding the real value of unstable 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 but money consisted of bank notes, the real values of which were fully backed by gold reserves. Today depreciating or appreciating fiat money´s real value is backed by all the underlying value systems in an economy while the actual bank notes and coins simply represent depreciating real value since the materials the notes and coins are made of have almost no intrinsic value. Although the store of value function and permanently fixed nominal values of depreciating or appreciating bank notes and bank coins are legally defined, fiat money´s real value is determined by all the underlying values systems in an economy. The change in fiat money´s depreciating or appreciating real value is indicated by the economic processes of inflation and deflation respectively.

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

Money is a liquid medium of exchange; i.e. it is readily available as cash and it is normally easy to obtain on demand in banks in most economies under normal economic conditions – all else being equal. A property, e.g. a well–located plot of land with a well–maintained and well–equipped building – which is a variable real value non–monetary item – 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 continuously being eroded 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 erodes the real value of only money and other monetary items. Inflation does not manifest itself in money’s medium of exchange function in the case of spot transactions (since the exchange is made between money and the other item considered to be equal in real value to the money amount at the moment of exchange) or unit of account function (the stable measuring unit assumption manifests itself in money´s unit of account function) which vindicates the fact that inflation can only erode 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 during inflation or the increasing real value of money during deflation into account (amongst many other factors) so that economic items (the product or service or right and the amount of money) of equal real value are exchanged at the moment of exchange.

Depreciating money has a constantly decreasing real value during inflation. Depreciating “bank money” deposits have the same attributes as depreciating money with the single exception that they are not physical depreciating bank notes and bank coins but accounted depreciating monetary items. The depreciating money represented by depreciating bank money also has a depreciating store of value function during inflation. Money appreciates in real value during deflation.

Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

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