View source for Finance:Medium of exchange

{{Short description|Method by which value is transferred between parties.}}
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In [[Finance:Economics|economics]], a '''medium of exchange''' is any item that is widely acceptable in exchange for goods and services.<ref name=":0">{{Cite book|last=Black, John, 1969





|url=https://www.worldcat.org/oclc/970401192|title=A dictionary of economics |others=Hashimzade, Nigar,, Myles, Gareth D.|year=2017|isbn=978-0-19-181994-0 |edition=5|location=[Oxford]|oclc=970401192}}</ref> In modern economies, the most commonly used medium of exchange is [[Finance:Currency|currency]]. Most forms of money are categorised as mediums of exchange, including commodity money, [[Finance:Representative money|representative money]], [[Finance:Cryptocurrency|cryptocurrency]], and most commonly [[Finance:Fiat money|fiat money]]. Representative and fiat money most widely exist in [[Finance:Digital currency|digital form]] as well as physical tokens, for example [[Finance:Coin|coin]]s and notes.

The origin of "mediums of exchange" in human societies is assumed by economists, such as William Stanley Jevons, to have arisen in antiquity as awareness grew of the [[Finance:Barter#Limitations|limitations of barter]]. The form of the "medium of exchange" follows that of a token, which has been further refined as [[Finance:Money|money]]. A "medium of exchange" is considered one of the [[Finance:Money#Functions|functions of money]].{{r|mankiw|krugman|abelbernanke}} The exchange acts as an intermediary instrument as the use can be to acquire any good or service and avoids the [[Finance:Barter#Limitations|limitations of barter]]; where what one wants has to be matched with what the other has to offer.<ref>William Stanley Jevons, 1875. 'Money and the mechanism of exchange' Chapter 1 http://oll.libertyfund.org/titles/jevons-money-and-the-mechanism-of-exchange</ref><ref>{{Cite web|url=https://www.investopedia.com/terms/m/mediumofexchange.asp|title=Medium of Exchange Definition}}</ref> However, there is little evidence of a pre-monetary society in which barter is the primary mode of exchange;<ref name="Humphrey, Caroline 1985">Humphrey, Caroline. 1985. "Barter and Economic Disintegration". Man, New Series 20 (1): 48–72.</ref>
instead, such societies operated largely along the principles of [[Finance:Gift economy|gift economy]] and [[Finance:Debt|debt]].<ref>[[Biography:Marcel Mauss|Mauss, Marcel]]. ''The Gift: The Form and Reason for Exchange in Archaic Societies''. pp. 36–37.</ref><ref>{{cite web |url=http://www.nakedcapitalism.com/2011/08/what-is-debt-%E2%80%93-an-interview-with-economic-anthropologist-david-graeber.html |title=What is Debt? – An Interview with Economic Anthropologist David Graeber |publisher=Naked Capitalism|date=2011-08-26 }}</ref><ref>David Graeber: ''Debt: The First 5000 Years'', Melville 2011. Cf. [http://socialtextjournal.org/a-history-of-debt/ review]</ref>

==Theories on the origin of money==
===Credit as the origin of money===
{{Excerpt|History of money|Hypothesis of credit as the origin of money}}

===Barter as the origin of money===
In a [[Finance:Barter|barter]] transaction, one valuable good is exchanged for another of approximately equivalent value. [[Biography:William Stanley Jevons|William Stanley Jevons]] described how a widely accepted medium allows each barter exchange to be split into three difficulties of barter.<ref>William Stanley Jevons, 1875. 'Money and the mechanism of exchange' Chapter 4 http://oll.libertyfund.org/titles/jevons-money-and-the-mechanism-of-exchange</ref> A medium of exchange is deemed to eliminate the need for a [[Finance:Coincidence of wants|coincidence of wants]].

====Want of coincidence====
A barter exchange requires each party to a transaction to have something the other desires. A medium of exchange removes that requirement, allowing an individual to sell and buy from various parties via an intermediary instrument.

====Want of a measure of value====
A barter market theoretically requires a value being known of every commodity, which is both impractical to arrange and impractical to maintain. If all exchanges go 'through' an intermediate medium, such as money, then goods can be priced in terms of that one medium. The medium of exchange allows the relative values of items in the marketplace to be set and adjusted with ease. This is a dimension of the modern [[Finance:Fiat money|fiat money]] system referred to as a "[[Finance:Unit of account|unit of account]]"<ref>{{Cite journal|last1=KIM|first1=YOUNG SIK|last2=LEE|first2=MANJONG|date=2013-11-22|title=Separation of Unit of Account from Medium of Exchange |url=http://dx.doi.org/10.1111/jmcb.12066|journal=Journal of Money, Credit and Banking|volume=45|issue=8|pages=1685–1703|doi=10.1111/jmcb.12066|issn=0022-2879}}</ref>

====Want of means of subdivision====
A barter transaction requires that both objects being bartered be of equivalent value. A medium of exchange is able to be subdivided into small enough units to approximate the value of any good or service.

====Transactions over time====
A barter transaction typically happens on the spot or over a short period of time. Money, on the other hand, also functions as a [[Finance:Store of value|store of value]], until what is wanted becomes available.

== Mutual impedance with store-of-value function ==
An ideal medium of exchange is spread throughout the marketplace to allow individuals with exchange potential to buy and sell. When money serves the function of a [[Finance:Store of value|store of value]], as [[Finance:Fiat money|fiat money]] does, there are conflicting drivers of monetary policy. This is because a store of value can become more valuable if it is scarce in the marketplace.<ref>T.H. Greco. ''Money: Understanding and Creating Alternatives to Legal Tender'', White River Junction, Vt: Chelsea Green Publishing (2001). {{ISBN|1-890132-37-3}}</ref> When the medium of exchange is scarce, traders will pay to rent it ([[Finance:Interest|interest]]), which acts as an impedance to trade.  In stable or deflationary environments, interest is a net transfer of wealth from debtor to creditor with the opposite transfer under inflationary environments.

== Medium of exchange and measure of value ==
Fiat currencies function as money with "no intrinsic value" <ref name=":0" /> but rather exchange values which facilitate a measurable value of exchange. The market measures or sets the real value of various goods and services using the medium of exchange as a unit of measure i.e., standard or the yard stick of measurement of wealth.<ref name=":1" /> There is no other alternative to the mechanism used by the market to set, determine, or measure the value of various goods and services. Determination of price is an essential condition for justice in exchange, efficient allocation of resources, economic growth, welfare and justice. 
The most important and essential function of a medium of exchange is to be widely acceptable and have relatively stable purchasing power (real value). The following characteristics are essential:

# Value common assets
# Common and accessible
# Constant utility
#Low cost of preservation
#Transportability
#Divisibility
#High market value in relation to volume and weight
#Recognisability
#Resistance to counterfeiting

To serve as a measure of value, a medium of exchange requires constant inherent value of its own or must be firmly linked to a definite basket of goods and services. Furthermore, constant intrinsic value{{Dubious|date=September 2018}} and stable purchasing power are needed. Gold was long popular as a medium of exchange{{Dubious|date=September 2018}} ''and'' [[Finance:Store of value|store of value]] because it was [[Chemistry:Chemically inert|inert]], meaning it was convenient to move due to even small amounts of gold having a considerable and constant value{{Dubious|date=September 2018}}.

Some critics of the prevailing system of [[Finance:Fiat money|fiat money]] argue that fiat money is the root cause of the continuum of economic crises, since it leads to the dominance of fraud, corruption, and manipulation, precisely as it does not satisfy the criteria for a medium of exchange cited above. Specifically, prevailing fiat money is free-floating, and depending upon its supply market finds or sets a value to it that continues to change as the supply of money shifts with respect to the economy's demand. Increasing free-floating money supply with respect to needs of the economy reduces the quantity of the basket of the goods and services. It is not a unit or standard measure of wealth and so the manipulation impedes the market mechanism by setting or  determining just prices. This leads to a situation where no value-related economic data is just or reliable.<ref name=":1">Hifzur Rab (2009) 'Freedom, Justice and Peace Possible Only with Correct wealth measurement with a Unit of Wealth as Currency'  HIJSE 26:1, 2010</ref><ref>Hifzur Rab (2006) 'Economic Justice in Islam' AS Noordeen, Kuala Lumpur, Malaysia.</ref> On the other hand, [[Finance:Chartalism|Chartalists]] claim that the ability to manipulate the value of fiat money is an advantage, in that fiscal stimulus is more easily available in times of economic crisis.

== Requisites needed ==
Although the [[Finance:Unit of account|unit of account]] must be in some way related to the medium of exchange in use, e.g. ensuring [[Finance:Currency|coinage]] is in denominations of that unit, making [[Finance:Accounting|accounting]] simpler to perform, it is more often the case that media of exchange have no natural relationship to that unit, and must be 'minted' as having that value. Further, there may be variances in quality of the underlying good which may not have fully agreed [[Social:Value (marketing)|perceived value]] grading. The difference between the two functions becomes obvious when one considers the fact that coins were very often 'shaved.' Precious metal was removed from them, leaving them still useful as an identifiable coin in the marketplace, for a certain number of units in trade, but which no longer had the quantity of metal supplied by the coin's minter. It was observed as early as Oresme, Copernicus and then in 1558 by Sir Thomas Gresham, that "bad" money drives out "good" in any marketplace; (Gresham's Law states "Where legal tender laws exist, bad money drives out good money"). A more precise definition follows that: "A currency that is artificially overvalued by law will drive out of circulation a currency that is artificially undervalued by that law." Gresham's law is a specific application of the general law of price controls. A common explanation is that people will always keep the less adultered, less clipped, less filed, less trimmed coin, and offer the other in the marketplace for the full units for which it is marked. It is inevitably the bad coins proffered, good ones retained.

[[Social:Bank|Bank]]s as financial intermediaries between ultimate savers and borrowers,<ref>{{Cite book|last=Llewellyn, David T.|url=https://www.worldcat.org/oclc/48877769|title=The new economics of banking|date=1999|publisher=Société universitaire européenne de recherches financières|isbn=90-5143-028-0|location=Amsterdam|oclc=48877769}}</ref> and their ability to generate a medium of exchange marked higher than a fiat currency's store of value, is the basis of [[Finance:Banking|banking]]. Central banking is based on the principle that no medium requires more than the guarantee of the state that it can be redeemed for payment of [[Finance:Debt|debt]] as "[[Finance:Legal tender|legal tender]]" – so all money equally backed by the state is considered good money, within that state.{{Dubious|date=March 2010}} So long as that state produces anything of value to others, the medium of exchange has some value, and the currency may also be useful as a [[Finance:Standard of deferred payment|standard of deferred payment]] among others.

Of all functions of money, the medium of exchange function has historically been the most problematic due to counterfeiting, the systematic and deliberate creation of bad money with no authorization to do so, leading to the driving out of the good money entirely.

Other functions rely not on recognition of some token or weight of metal in a marketplace, where time to detect any counterfeit is limited and benefits for successful passing-off are high, but on more stable long term [[Social:Social contract|social contract]]s: one cannot easily force a whole society to accept a different standard of deferred payment, require even small groups of people to uphold a floor price for a store of value, still less to re-price everything and rewrite all accounts to a unit of account (the most stable function). Thus it tends to be the medium of exchange function that constrains what can be used as a form of [[Social:Financial capital|financial capital]].

It was once common in the {{wipe|United States}} to widely accept a check ({{lang-en-GB|[[Finance:Cheque|cheque]]}}) as a medium of exchange, several parties endorsing it perhaps multiple times before it would eventually be deposited for its value in units of account, and thus redeemed. This practice became less common as it was exploited by forgers and led to a [[Philosophy:Domino effect|domino effect]] of bounced checks – a forerunner of the kind of fragility that electronic systems would eventually bring.

In the age of electronic money it was, and remains, common to use very long strings of difficult-to-reproduce numbers, generated by [[Encryption|encryption]] methods, to authenticate transactions and commitments as having come from trusted parties. Thus the medium of exchange function has become wholly a part of the marketplace and its signals, and is utterly integrated with the unit of account function, so that, given the integrity of the public key system on which these are based, they become to that degree inseparable. This has clear advantages – counterfeiting is difficult or impossible unless the whole system is compromised, say by a new [[Integer factorization|factoring algorithm]]. But at that point, the entire system is broken and the whole infrastructure is obsolete – new keys must be re-generated and the new system will also depend on some assumptions about difficulty of factoring.

Due to this inherent fragility, which is even more profound with [[Social:Electronic voting|electronic voting]], some economists argue that units of account should not ever be abstracted or confused with the nominal units or tokens used in exchange. A medium is simply a medium, and should not be confused for the message.{{Dubious|date=December 2008}}

== See also ==
{{cols}}
* [[Authentication]]
* [[Finance:Cheque|Cheque]]
* Commodity money
* Forgery
* History of money
* [[Identity theft]]
* Private currency
{{colend}}

==References==
{{reflist|refs=

<ref name=abelbernanke>{{cite book |last1=Abel |first1=Andrew |last2=Bernanke |first2=Ben |title=Macroeconomics |publisher=Pearson |year=2005 |edition=5th |pages=266–269 |chapter=7 |isbn=0-201-32789-9}}</ref>

<ref name=mankiw>{{cite book |title=Macroeconomics |last=Mankiw |first=N. Gregory |year=2007 |edition=6th |pages=[https://archive.org/details/macroeconomics0000mank/page/22 22–32] |chapter=2 |publisher=Worth Publishers |location=New York |isbn=978-0-7167-6213-3 |chapter-url=https://archive.org/details/macroeconomics0000mank/page/22 }}</ref>

<ref name=krugman>Krugman, Paul & Wells, Robin, ''Economics'', Worth Publishers, New York (2006)</ref>

}}

== Bibliography ==
* Jones, Robert A. "The Origin and Development of Media of Exchange." Journal of Political Economy 84 (Nov. 1976): 757-775.

== External links ==
* [https://web.archive.org/web/20070614014529/https://www.egwald.com/ubcstudent/aboriginal/exchanges.php Linguistic and Commodity Exchanges]-Examines the structural differences between barter and monetary commodity exchanges and oral and written linguistic exchanges.

{{Economics}}
{{Means of Exchange}}

[[Category:Currency]]

{{Sourceattribution|Medium of exchange}}