Throughout history and around the world, moneyhas taken diverse forms – from cowrie shells, copperingots, rum and gold coins in the past, through tocolourful pieces of paper or polymer and digital bankrecords today (see images 1, 2, 3 and 4). ThroughoutAustralia's own history, a variety of different tokens ofexchange have been used as money (see Box: EarlyForms of Money in Australia). What links these differentforms of money is not their physical qualities butthe function they perform: each in their era weretrusted as a reliable way to pay or be paid, as a way toquote prices and as a way to store value over time. Inother words, they were a:
- widely accepted means of payment
- unit of account
- store of value.
These three attributes are in fact the standarddefinition of what makes something ‘money’.
The material or item used as money does not need tohave any value in its own right. Some forms of moneyhave had this feature (e.g. gold coins, copper ingots),while others have not (e.g. paper banknotes). Rather,money derives its value from the trust people place init. History shows, however, that this trust can be lost ifmismanaged. For example, if too much paper money isprinted and issued, the value of the money will fall; thatis, high inflation will result. In fact, hyperinflation canresult. This has happened many times through history,including in Zimbabwe in the late 2000s, resultingin the population abandoning the Zimbabwe dollar(see image 5) and switching to other, more stablecurrencies such as the US dollar.
Maintaining a stable currency and avoiding highinflation is in fact one of the core functions ofcentral banks. Indeed, the Reserve Bank Act 1959,which established the Reserve Bank, explicitlysingled out ‘the stability of the currency’ as oneof the Reserve Bank Board's three aims (theothers being full employment, and the economicprosperity and welfare of the people of Australia).
In the colonial period when coins were inshort supply, bottles of rum were used as aform of currency.
Image: Hyde Park Barracks Museum collection, Sydney Living Museums, HPB/UG269.
An ancient Roman coin made from gold,depicting the Emperor Augustus, datingfrom between 4 BC and 2 AD.
Museums Victoria, NU 22518.
Cowrie shells, such as this one fromZanzibar in east Africa, have traditionallybeen used as a form of currency innumerous parts of Asia, Africa and Oceania.
Image: British Museum, 2014, 2011.38.
Image: Reserve Bank of Australia
Image: National Museum of American History, Smithsonian Institution. 2015.0071.1.
Box: Early Forms of Money in Australia
When the colony of New South Wales wasestablished in 1788, colonists relied on barter and rum(spirits) as a makeshift currency. In 1792, a shipment ofSpanish dollars was sent to Australia for use ascurrency alongside the other international currenciesthat were used in the colony at the time. To addresspersistent coin shortages, new forms of money weredeveloped in the following decades. These includedthe creation of the holey dollar and dump byGovernor Macquarie (see images 6 and 7) (whichmade two coins out of one), the use of promissorynotes (see image 8) or IOUs, and copper tokens(see image 9) issued by businesses. IOUs and coppertokens proved an unreliable source of currency, partlybecause they had no official guarantee.
In 1825, the British Government legislated a sterlingcurrency for the colony, which remained the basisof Australian currency until the transition to decimalcurrency, the Australian dollar, in 1966. Australia's firstgold coins were minted in 1855. The gold rushesspurred the development of banking andcommercial banks issued banknotes backed bygold, though these banknotes did not constitute anational currency. Like many other countries at thetime, Australia adhered to the gold standard andthe total amount of notes that banks could issuewas limited by their gold reserves. Under the goldstandard, money was ‘backed’ by gold – countriesagreed to convert paper money into a fixedamount of gold. At the turn of the twentiethcentury, Australia's currency remained a mixture ofBritish coins, Australian coins and the notes ofprivate banks and the Queensland Government.
In 1910, legislation for a national currency wasenacted. The Australian Government issued‘superscribed’ banknotes, whereby words wereoverprinted on notes purchased from the privatebanks (see image 10). These were the firstcurrency notes accepted across the nation. Thefirst true Australian banknote was produced inMay 1913, with additional denominationsproduced from 1913 to 1915.
A five shillings or ‘holey dollar’ coin created in 1813.
Image: State Library of New South Wales, FL390234.
A fifteen pence or ‘dump’ coin created by puncturing a ‘holey dollar’ coin.
Image: State Library of New South Wales, FL398749.
A promissory note issued in Hobart in 1826.
Image: Note Printing Australia Limited.
A gold sovereign coin, produced in 1855 at the Sydney Mint.
10. A £10 banknote originally issued by the Bank of Adelaide in1910, superscribed by the Commonwealth Treasury.
Image: Reserve Bank of Australia archives, NP-004014.
Learn more about how banknotes are produced in the Bulletin article on Moneyin the Australian Economy.
Why do we need money?
Money has value because people trust that ithas value today and will continue having valuein the future. But history shows that this trust issometimes broken, so why do people keep onusing money? The answer is that it is incrediblyuseful for facilitating trade, which in turn has led tohigher living standards.
Trade allows people to specialise in producingthose things in which they have a comparativeadvantage. Even the most capable person wouldstruggle if they had to find food, build shelterand make clothes entirely on their own. If thatindividual lived within a community, however, andcould trade with others, then each communitymember could specialise in one area – maybefishing, building houses or making clothes – andbecome very skilled in that task. By trading witheach other, each member of the communitywould benefit from the specialist skills developedby the other community members.
So what is the role of money? It enables productionand trade on a large scale. If you live in a small villagewhere you know and trust everyone, you may bewilling to give up some of your fish catch today toothers in the knowledge that when you need (forexample) clothes, the tailor will give you somethingto wear. If you live in a larger town, where you maynot know or trust people so well, you probablywon't give away your fish to anyone who asks, as youmight not trust, for example, that a tailor will give younew clothes if you ask later on. While you could tryto solve this problem of lack of trust with barter,barter usually doesn't work very well. For example,the tailor might not want your fish when you neednew clothes – indeed, the tailor might not ever wantfish, nor have the specific clothes you need. Withmoney, however, you can sell your fish to whoeverwants fish, save some of the money they pay youand take it to the tailor when you need clothes (orto whomever you want to purchase somethingfrom and whenever you need to).
In brief, money makes trade with people we mightnot know or trust possible, and trade makes asociety prosperous. Trust is now placed in thevalue of money, rather than in every person wemight want to buy from or sell to.
What forms of money are usedin a modern economy?
There are two main forms of money that exist inmodern economies:
- coins and banknotes (i.e. currency)
- deposits held in accounts at banks or otherauthorised deposit-taking institutions.
Currency is a physical form of money, whiledeposits held in accounts with a financialinstitution are a digital form of money andcomprise the greatest share of money in a moderneconomy. (Learn more in the Bulletin article onMoney in the Australian Economy.) There is alsoa subtle difference between currency and depositaccount balances. Currency is backed by thecentral bank, which eliminates any risk of default.Deposit account balances, on the other hand, areliabilities of privately owned financial institutions(because the depositor can ask for them back) andthese institutions are at possible risk from default.Nonetheless, while this risk has materialisedin some countries, in Australia it is extremelylow. (Australia's banks are well capitalised andregulated, depositors are paid out first if a bankgets into trouble, and there is a Financial ClaimsScheme in which the government provides alimited guarantee for household deposits ofindividuals below $250,000.)
What is legal tender?
Legal tender is a form of payment recognisedby the legal system such that, when it is offered(‘tendered’) in payment of a debt, the debt islegally discharged (i.e. the creditor cannot refusea legal tender and then later pursue the debtorin court for the debt). Banknotes are legal tenderunder the Reserve Bank Act 1959 and coins are legaltender under the Currency Act 1965. The systemof money, where the currency of a country is notbacked by a physical commodity (e.g. gold) but bya directive from a government that makes it legal,is called a ‘Fiat’ system.
How is money created?
Australia's banknotes are produced by the ReserveBank of Australia, while coins are produced bythe Royal Australian Mint. Banknotes accountfor most of the value of physical money and wefocus on them in this Explainer. Under establishedagreements, commercial banks purchasebanknotes from the Reserve Bank as requiredto meet demand from their customers. Hence,growth in the value of banknotes in circulationrepresents growth in the demand for cash fromthe general public.
From the perspective of money ‘creation’, depositscan also be created when financial intermediariesmake loans.[1] While the process of extending loansis central to the process of money creation, thisdoes not mean that financial intermediaries areable to make loans and create money withoutlimits. Deposit-taking institutions need to meetcertain regulatory requirements and must besatisfied that borrowers can pay back their debts.
Deposits can also be created by the Reserve Bank, such as when the Reserve Bankpurchases government bonds (for more information, see Explainer: How the Reserve Bank ImplementsMonetary Policy). When the Reserve Bank purchases government bonds from the non-bankprivate sector, households and businesses ultimately deposit the proceeds of the saleinto the banking system, adding to total deposits.
Is Bitcoin money?
Bitcoin, and other ‘cryptocurrencies’, fulfil someof the attributes of money, but not all of them.Most notably, they can be used as a medium ofexchange – some businesses and individuals willaccept bitcoin as payment, though the number ofbusinesses willing to accept bitcoin is low (i.e. it isnot a widely accepted means of payment). On theother two attributes of money – being a unit ofaccount and a store of value – bitcoin fails. Shopsdo not quote prices in bitcoins; rather, shops thataccept bitcoin typically quote prices in the localcurrency and then do a conversion to bitcoin atthe current exchange rate if someone wants topay that way. They do this in part because theprice of bitcoin is very volatile, with this volatilitybeing one reason why bitcoin is a poor storeof value. (For more information seeExplainer: Digital Currencies.)
Why don't all countries use thesame money?
While a single, stable form of money used byevery country in the world would help peoplespend and save with confidence and plan forthe future, it would make it harder for individualeconomies to respond to economic shocks.By having their own unit of account (i.e. theirown currency), countries have more flexibility ineconomic management. They can choose to allowthe value of their currency to fluctuate freely inresponse to economic events and to conduct theirown economic policies (in particular monetarypolicy) independently of those in other countries.Consequently, individual countries (or groups ofcountries with similar economic features, e.g. themember countries of the euro area) usually havetheir own currency.
What is the future of money?
Money has changed form many times over theyears, but for as long as complex societies haveexisted, there has been money. The only confidentprediction that can be made about money is thatas long as people want to trade with each other,money will continue to exist in some form becausethe functions it performs are central to sustainingeconomic activity.
While payments by governments increase the deposits in accounts of households orbusinesses at banks or other deposit-taking institutions, they donot create money because they must be funded by an offsetting transaction that reducesdeposits. A government transfer that increases the depositsheld by households must be funded by issuing bonds or taxation, both of which reducedeposits.[1]
