The Purpose of Money
Let's clear up some of the confusion about the purpose of money.
Money consists of any economic good, or any claim on such a good, that serves as a general medium of indirect exchange and that acts as a final means of payment.
Although people widely use what they refer to as money, they don’t seem to have a clear understanding of its purpose in the market. In the preceding publication [Money Definition Explained] I broke down the component parts of that definition. In this publication, I will delve more deeply into the purpose that money serves in the market.
To help clarify the purpose of money, I will first clear up some popular misunderstandings about the purpose of money. Then, I will clarify the single purpose of money.
Misunderstandings
Before I address the purpose of money directly, I would like to clear up some misunderstandings.
Store of Value
In spite of the popular misconception, money cannot act as a store of value. Value exists only in the subjective preferences of individuals. Nothing can act as a store of value, including money.
Unit of Account
Financial records use money units to record transactions. Bookkeepers and accountants do this because it tends to be the only common unit in which transactions occur. But, the dollars on a financial state only count the dollars. They do not count the goods purchased with those dollars. Measures such as ounces, pounds, or just units would serve as units of account, but they could not be summed in any meaningful way.
Medium of Exchange
When asked about the purpose of money, most economists would chant “medium of exchange.” Those chants contain a partial truth but not the most important distinction.
If a farmer goes to market and travels from shop to shop, trading varying quantities of grain for different goods, the grain would act as a medium of exchange. The grain would lack a critically important purpose. Those trades would consist of direct exchanges in which the farmer would have the intent of consuming the goods acquired.
If the same farmer accepted a good he had no intention of consuming but wanted to trade again for another good, that would consist of an indirect exchange. Anything serving as money would also qualify as a medium of indirect exchange.
Debt
All too often, I have heard people mistakenly equate money with debt. A distinct difference exists between money-claims and debt. Any entity that issues a claim must honor it immediately upon the demand of the holder. A debt has a specific time for redemption—even if only the next day. This distinction separates money from debts.
Clarification of Purpose
Money has a single purpose: as a general medium of indirect exchange.
Does Not Require Increased Quantity
Because traders use money only for indirect exchange, it almost never gets consumed. Therefore, the quantity need never change. We do not need more money for more exchanges.
Calculation
Indeed, since we express prices in terms of money, the quantity of money should never change. Buyers should have the confidence that money prices change only in response to changes in quantity or the perceived value of goods.
Money prices, not money, give us an objective measure for the purpose of economic calculation. Producers and consumers use money prices to effectively and efficiently allocate resources throughout the economy.
Conclusion
I cannot say it often enough:
Because it serves the purpose as a general medium of indirect exchange the quantity of money in a market need not (indeed, should not) ever change.
Artificial change in the quantity of money causes erroneous price information, which leads to the misallocation of resources and boom and bust business cycles.