Money is said to have three characteristics: medium of exchange (can use it to buy and sell goods and services); store of value (can save it and use it at a later date); and unit of account (provides a common base for prices). But, as we shall see, what we normally consider money – bank notes and the money in our bank accounts – does not always live up to those characteristics. Plus there are other myths around money that need to be questioned.
Medium of exchange
I was in London earlier in the year. After arriving at Heathrow I couldn’t be bothered finding an ATM so I used my credit card to catch the tube to my hotel. Nor did I get cash before going to a Korean cafe for dinner, even though it only took cash: I had over £20 mostly in one pound coins from my last trip a few years ago. When I went to pay, however, I was told that the restaurant didn’t accept “old” pound coins – the pound coins had been replaced two months earlier. Luckily there was an ATM five minutes’ walk away.
To be sure, countries do change their coins and bank notes from time to time. In New Zealand, the Reserve Bank of New Zealand will pay you the face value of old notes and coins no longer in use.
But what about money still in circulation? Well good luck trying to spend £50 notes in London. Signs in many shops stated they were not accepted because of the large numbers of counterfeit notes. Holders of £50 notes can go to a bank, assuming they have not unwittingly received counterfeits, and convert them into smaller denominations.
What these experiences show is not all bank notes are a medium of exchange, or even a useful medium of exchange.
Store of value
If you want to store money to use decades later, hoarding bank notes is extremely unwise. In the 1930s, US$3300 would have bought a house and in the 1960s, a new car. But it would barely buy a second-hand car today. Hoarding gold would have been a bit better as it would have “increased” to US$10,908 today. This useful inflation calculator shows how much money has decreased in purchasing power in New Zealand.
As we have seen throughout history, money is only as good as the country behind that money. In Venezuela, hyperinflation means that a person on the median wage, even if they spend all their wages on food, can only purchase 900 calories of food a day – which is not enough to sustain a person let alone provide for a family.
In Zimbabwe, the highest note printed during its relatively recent bout of hyperinflation was 100 trillion (100,000,000,000,000) and even then it would not even cover a bus fare. Not surprisingly, given the number of zeros on the notes, they are now collector’s items.
Therefore, bank notes are not a good store of value.
Unit of account
Our goods and services in New Zealand are priced in New Zealand dollars. When shopping online, depending on the website, the prices will either be shown in the New Zealand dollar or the country where the online retailer is based. Therefore, money does serve as a unit of account.
Before looking at other myths about money, some will argue that given the problems with bank notes we would be much better giving up cash and going entirely digital. However, there are potential dangers with such a move, not least because not everyone in New Zealand has a bank account. Indeed, one of the potential options in the Reserve Bank’s recent work on removing cash and issuing a central bank digital currency would see currency on cards, such as Visa Prezzy cards, for which no bank account is required.
I was discussing cryptocurrencies recently and the person I was talking to suggested Bitcoin and other cryptocurrencies were not real as they were just computer code which people created from thin air. She preferred real money, like bank notes, that you can hold in your hands.
The problem with her argument though is that almost all of the money in New Zealand, and many other countries, is not in bank notes. That “money” is simply figures on banks’ databases – that is, it is digital. As the Reserve Bank has recently explained, the money in commercial bank accounts is digital currency.
Moreover, all of New Zealand’s money (except for bank notes and coins) was in fact created by the commercial banks, such as Westpac, ASB and ANZ, by a process called fractional reserve banking. The fact that the Reserve Bank does not create most of the money in New Zealand comes as a surprise to many people.
If everyone, or even a good chunk of the population, attempted to withdraw all their money in their bank accounts in cash it would cause a run on the banks and would cause an economic crisis as occurred in Greece.
Interestingly, cash, especially high denomination notes such as the $100 note, are used commonly by criminals including terrorists, drug smugglers and people traffickers. Ironically the government – by printing the notes – is assisting illegal activity.
What about the money in your bank account? Surely it is yours to withdraw and spend as you want (and unlike banknotes will not be replaced like the pound coins). The problem is that when you put money in a bank account you are giving the money to the bank and you become an unsecured creditor. Unlike in other countries we have no depositors’ insurance.
In addition, banks can freeze bank accounts and prevent money being withdrawn. In the past week, bank accounts have been frozen because of changes to changes to OECD regulations over tax residency.
While some might argue that Bitcoin and other cryptocurrencies are a good store of value, because, for example, Bitcoin is limited to only 21 million coins, the dramatic fall of the price of Bitcoin and other cryptocurrencies this year demonstrate that they should not be viewed as a store of value.
It is not surprising that myths abound given that movies such as Mary Poppins have peddled myths about money for years.