Tuesday, November 23, 2010

On the Homogeneity of Money

Today's lesson in money comes courtesy of the comic strip Frazz.


One of the fundamental characteristics of money is homogeneity. That essentially means each monetary unit is the same as every other unit. They are interchangeable. This concept is sometimes hard for some people to understand - especially the very young. They often view banks as warehouses. They may believe that if you deposit five $1 bills in your account, the teller takes those five bills and puts them in a drawer with your name on it. When you withdraw five dollars, the teller will give you the same five bills.

Those of us with more experience know that isn't true. That your five dollar bills are intermixed with others and they circulate. The chance of receiving bills is very, very remote.

But because money is homogenous, it helps to make a fractional reserve banking system possible. As long as everyone doesn't demand their money at the same time, money can be lent. Those wanting to withdraw funds can be given any cash on hand.

But when too much is lent and there's a demand for funds, a fractional reserve system can become illiquid. That's one reason for a central bank. The discussion can go much farther from here, but the lesson in the cartoon is that the money we put in is not necessarily the same money we take out. The deeper discussion may be why.


Faizan. Q (fizzy) said...

In the "Homogeneity of Money", it makes the occurrence of trade-off in supplies much easier. We're able to exchange goods, invest, consume materials, and much more because of a piece of paper that we put value into. However, our ability to consider the money to be at such a value is truly remarkable because what if sudden high inflation causes the dollar or any other currency to lose all of its value. In a advance world, we should consider something other than money to be effective due to the risk but for now it serves its purpose.

Christina said...

Depending on the timing and the value of the dollar or commodity (like gold), this can have negative or positive effects on the value, right? Like in the case of the Great Depression, large investors influenced pricing and interest rates. The value of the dollar is also influenced by monetary policy, which we are currently learning about in my high school economics class.