Money performs the following three functions:
1
Unstable medium of exchange
2
Unstable store of value
3
Unstable unit of account
Unstable medium of exchange
Money has the basic function that it is an unstable medium of exchange.
It overcomes the inconveniences of a barter economy where there must be a
double coincidence of wants before a trade can take place. For a trade to take
place in a barter economy one person must want exactly what the other person
has to offer, at the exact time and place where it is offered.
In a monetary economy the real value of goods and services are measured
in terms of unstable money, the unstable monetary medium of exchange, which is
generally accepted to buy any other good or service. Without this function or
attribute the invention cannot be money.
We use payment with unstable money instead of barter to exchange real
values in our economies in the transactions we enter into when we buy and sell
goods, services, ideas, rights and any kind of property whether physical,
virtual or intellectual. Unstable money is the lifeblood of an economy even
though it is continuously changing in real value. The creation and exchange of
real value in an economy would be severely restricted without unstable money since it would be a barter
economy.
Unstable store of value
Unstable money is an unstable store of real 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. The first types of money consisted of gold
and 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 metals but money consisted of bank notes, the
real value of which was fully backed by gold. 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 are simply physical
tokens of money since the materials the notes and coins are made of have almost
no intrinsic value. Although the store of value function (legal tender) and
permanently fixed nominal values of depreciating or appreciating bank notes and
bank coins are legally defined, fiat money´s real value is in fact determined
by all the underlying values systems in an economy. The daily change in fiat
money´s depreciating or appreciating real value is indicated by the change in
the Daily CPI.
The abuse of money’s store of value function led to inflation.
Money in the form of bank notes and coins and in the
form of virtual real values in bank and credit card accounts are liquid media
of exchange; i.e., they are readily available. It
is normally easy to obtain cash on demand in banks in most economies under
normal economic conditions. 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 small denominations which facilitate everyday small purchases. As
such, money is very user friendly. It is easily transportable especially with
electronic transfer facilities (2012).
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 (a) 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 and also since (b) inflation only
happens over time. Inflation also does not manifest itself in money’s 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 other 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 and other monetary items appreciate in real value during
deflation.
Unstable money’s third function is that it is the unstable unit of
account in the economy. It is a monetary standard of measure of the real value
of economic items to facilitate exchange without barter in order to overcome
the double coincidence of wants problem. Inflation erodes the real value of
money and deflation increases the real value of money. Money has never been
perfectly stable in real value over an extended period of time. However, money
illusion makes people believe that money maintains its real value stable over
the short to medium term. Money is the only standard unit of measure that is
not a fundamentally stable or fixed unit of account. All other standards of measure
are perfectly stable units.
Accounting transformed money illusion into a Generally Accepted
Accounting Practice with the very destructive stable measuring unit assumption,
also called the Measuring Unit Principle.
‘The unit of measure in accounting shall be the base
money unit of the most relevant currency. This principle also assumes the unit
of measure is stable; that is, changes in its general purchasing power are not
considered sufficiently important to require adjustments to the basic financial
reports.’
Walgenbach,
Dittrich and Hanson 1973: 429
The very erosive stable measuring unit assumption is based on the
fallacy that changes in the general purchasing power (real value) of unstable
money are not sufficiently important to require adjustments to the basic
financial reports; i.e., not sufficiently important to require financial
capital maintenance in units of constant purchasing power during inflation and
deflation.
In an inflationary economy depreciating money is used as a depreciating
monetary unit of account to value and account economic activity. It is very
tempting to state that it is very clear that you cannot have a unit of account
in the economy that is not stable – not fixed – in real value for accounting
purposes. However, we have been doing exactly that since the start of inflation
in the economy; i.e., for about the last 3000 years. Accounting has been trying
to overcome this problem for the last 3000 years by simply assuming money is
perfectly stable in real value duirng inflation and deflation. However, a fact
will eventually prevail over an assumption regarding it. The assumption in
Historical Cost Accounting is that changes in the purchasing power of money are
not sufficiently important to require financial capital maintenance in units of
constant purchasing power during inflation and deflation. In practice that
means that unstable money is assumed to be perfectly stable in real value
during inflation and deflation. The fact is that money is not perfectly stable
in real value during inflation and deflation. Financial capital maintenance in
units of constant purchasign power during inflation and deflation implements
this fact instead of the stable measuring unit assumption under Historical Cost
Accounting. The stable measuring unit assumption is not implemented under
financial capital maintenance in units of constant purchasing power (CIPPA). The
problem stems from the difficulty in achieving zero inflation on a permanently
sustainable basis - never achieved to date (2012) - and the difficulty in
defining a universal unit of real value - also never achieved to date.
The only remedy to eliminate the erosion of real value in constant real
value non-monetary items never maintained constant during inflation and
deflation under HCA – besides permanently sustainable zero inflation – would be
to change over to financial capital maintenance in units of constant purchasing
power; i.e., the measurement of all constant items in units of constant purchasing
power in terms of a Daily Index during inflation and deflation (CIPPA).
The only remedy to eliminate the erosion of real value in money and
other monetary items – besides permanently sustainable zero inflation – would
be inflation-adjusting the entire money supply on a daily basis under complete
co-ordination. Chile
Nicolaas Smith
Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.
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