any medium of exchange that is widely accepted in payment for goods and services and in settlement of debts. Money also serves as a standard of value for measuring the relative worth of different goods and services. The number of units of money required to buy a commodity is the price of the commodity. The monetary unit chosen as a measure of value need not, however, be used widely, or even at all, as a medium of exchange. During the colonial period in America, for example, Spanish currency was an important medium of exchange, while the British pound served as the standard of value.

MONEY AND THE ECONOMY

The functions of money as a medium of exchange and a measure of value greatly facilitate the exchange of goods and services and the specialization of production. Without the use of money, trade would be reduced to barter, or the direct exchange of one commodity for another; this was the means used by primitive peoples, and barter is still practiced in some parts of the world. In a barter economy, a person having something to trade must find another who wants it and has something acceptable to offer in exchange. In a money economy, the owner of a commodity may sell it for money, which is acceptable in payment for goods, thus avoiding the time and effort that would be required to find someone who could make an acceptable trade. Money may thus be regarded as a keystone of modern economic life.

Types of Money.

The most important types of money are commodity money, credit money, and FIAT MONEY, The value of commodity money is about equal to the value of the material contained in it. The principal materials used for this type of money have been gold, silver, and copper. In ancient time, various articles made of these metals, as well as of iron and bronze, were used as money, while among primitive peoples such commodities as shells, beads, elephant tusks, furs, skins, and livestock served as mediums of exchange. The gold coins that circulated in the U.S. before 1933 were examples of commodity money. Credit money is paper backed by promises by the issuer, whether a government or a bank, to pay an equivalent value in the standard monetary metal. Paper money that is not redeemable in any other type of money and the value of which is fixed merely by government edict is known as fiat money. In the past, fiat money generally consisted of repudiated credit money, such as the U.S. note known as the GREENBACK, which was issued during the American Civil War. Most minor coins in circulation are also a form of fiat money, because the value of the material of which they are made is usually less than their value as money.

Both the fiat and credit forms of money are generally made acceptable through a government decree that all creditors must take the money in settlement of debts; the money is then referred to as legal tender. If the supply of paper money is not excessive in relation to the needs of trade and industry and the people feel confident that this situation will continue, the currency is likely to be generally acceptable and to be relatively stable in value. If, however, such currency is issued in excessively large volume in order to finance government needs, confidence is destroyed and it rapidly loses value. Such depreciation of the currency is often followed by formal devaluation, or reduction of the official value of the currency, by governmental decree.

Monetary Standards.

The basic money of a country, into which other forms of money may be converted and which determines the value of other kinds of money, is called the money of redemption or standard money. The monetary standard of a nation refers to the type of standard money used in the monetary system. Modern standards have been either commodity standards, in which either gold or silver has been chiefly used as standard money, or fiat standards, consisting of inconvertible currency paper units. The principal types of GOLD STANDARD, are the gold-coin standard, the standard in the U.S. until 1933; the gold-bullion standard, consisting of a specified quantity of gold; and the gold-exchange standard, under which the currency is convertible into the currency of some other country on the gold standard. The gold-bullion standard was used in Great Britain from 1925 to 1931, while a number of Latin American countries have used the dollar-exchange standard. Silver standards have been used in modern times chiefly in the Orient. Also, a bimetallic standard (see BIMETALLISM,) has been used in some countries, under which either gold or silver coins were the standard currency. Such systems were rarely successful, largely because of the operation of GRESHAM'S LAW, according to which cheaper money tends to drive more valuable money out of circulation.

Most monetary systems of the world at the present time are fiat systems; they do not allow free convertibility of the currency into a metallic standard, and money is given value by government fiat or edict rather than by its nominal gold or silver content. Modern systems are also described as managed currencies, because the value of the currency units depends to a considerable extent on government management and policies. Internally, the monetary system of the U.S. contains many elements of managed currency; although gold coinage is no longer permitted, gold may be owned, traded, or used for industrial purposes. It is a recurrent problem whether the value of inconvertible-credit currency can be maintained at a fairly stable level for extended periods of time.

Economic Importance.

Credit, or the use of a promise to pay in the future, is an invaluable supplement to money today. Most of the business transactions in the U.S. use credit instruments rather than currency. Bank deposits are commonly included in the monetary structure of a country; the term money supply denotes currency in circulation plus bank deposits.

The real value of money is determined by its purchasing power, which in turn depends on the level of commodity prices. According to the quantity theory of money, prices are determined largely or entirely by the volume of money outstanding. Experience has shown, however, that equally important in determining the price level are the speed of turnover of money and the volume of production of goods and services. The volume and speed of turnover of bank deposits are also significant. See NATIONAL INCOME,

THE MONETARY SYSTEM OF THE U.S.

In the American colonies, coins of almost every European country circulated, with the Spanish dollar predominating. Because of the scarcity of coins, the colonists also used various primitive mediums of exchange, such as bullets, tobacco, and animal skins; many of the colonies issued paper money that circulated at varying rates of discount. The first unified currency consisted of the notes issued by the Continental Congress to finance the American Revolution. These notes were originally declared redeemable in gold or silver coins, but redemption was found impossible after the Revolution because of the excess of printed notes over metal reserves. Thus, the notes depreciated and became nearly worthless.

Early Monetary Regulations.

In 1792 Congress passed the first coinage act, adopting a bimetallic standard under which both gold and silver coins were to be minted. The gold dollar contained 24.75 grains of pure gold and the silver dollar 15 times as much silver, making the legal mint ratio 15 to 1 (see DOLLAR,). At this ratio gold was undervalued at the mint, as compared with its value as bullion, and very little gold was presented for coinage. Silver dollars also were largely withdrawn from circulation, because they could be exported to the West Indies and exchanged at face value for slightly heavier Spanish dollars, which were then melted down and taken to the mint for coinage into American dollars at a profit. Until 1834, when Congress adopted a mint ratio of 16 to 1 by reducing the weight of the gold dollar, the metallic currency was limited mainly to a meager supply of small silver and copper coins. The first Bank of the United States, which existed from 1816 to 1836, issued banknotes that maintained a fairly stable value. Many state-chartered banks also issued notes that, because of the lax state banking laws, often greatly depreciated in value. After the closing of the second Bank of the United States, most of the paper currency consisted of notes of state-chartered banks and circulated only in a limited area.

After 1834, silver was undervalued at the mint; its market value was constantly higher than its coin value. As a result, gold gradually replaced silver in the monetary stock, especially after the discovery of gold in California in 1849. To relieve the famine in small coins, Congress, in 1853, reduced the weight of the half-dollars, quarters, and dimes by 7 percent. Because the new subsidiary coins were worth more as money than as bullion, it was possible to keep them in circulation. As a result of a revision of the coinage laws in 1873 the silver dollar was omitted from the list of coins authorized to be minted. Although the coinage of silver dollars was resumed in 1878, the metallic gold dollar remained the monetary standard of value in the U.S.; thus, bimetallism was legally discontinued and the gold standard adopted. Actually, silver dollars had been an insignificant part of the currency since early in the century.

During the Civil War the governments in both the North and the South financed their needs through the issue of fiat money. The notes issued by the Confederate treasury and the southern states became entirely worthless after the war. The U.S. notes (greenbacks) and other paper money issued by the federal government also depreciated rapidly, especially after the suspension of payment in specie (redemption of paper money with coins, usually of gold or silver) in 1861, and gold and silver coins were driven out of circulation. In 1863, the National Banking Act authorized the establishment of national banks that could issue bank notes backed by government bonds. A 10 percent tax levied on state bank notes in 1865 forced state banks to discontinue issuing them, thus giving the national banks a monopoly of bank-note issue. The state banks, however, remained an important element in the banking system.

After the elimination of the silver dollar in 1873, the greatly expanded production of silver in the West caused the value of silver to fall sharply and led to agitation by the silver interests for restoration of the free coinage of the silver dollar. In this effort they were joined by political groups who favored the free coinage of silver as a means of improving general economic conditions. This agitation led to the passage of the Bland-Allison Act in 1878 and the Sherman Act in 1890, under which the Treasury was directed to purchase larger amounts of silver for coinage. The former law also created the silver certificate, which remained an important part of U.S. currency until it was retired in 1968. The Sherman Act, which introduced into the stream of currency an enormous quantity of overvalued silver and caused a drastic decline in the gold reserve of the Treasury, helped to bring on the panic of 1893 and was repealed by Congress in that year. Even so, silver was the main issue in the 1896 presidential campaign, when William Jennings Bryan called for free coinage of silver at a ratio of 16 to 1. The silver forces were defeated, and in 1900 the Gold Standard Act affirmed the gold dollar as the standard unit of value.

Federal Reserve System.

The next important change in the currency system was introduced by the Federal Reserve Act of 1913, which authorized the establishment of 12 regional Federal Reserve banks, with power to issue two types of currency (see FEDERAL RESERVE SYSTEM,). The first, and most important, was the Federal Reserve note, which is issued under conditions consistent with economic stability and the needs of trade and industry. As member banks require more currency, they can obtain it from the Federal Reserve banks by drawing on their deposits or borrowing or rediscounting commercial paper if their deposit balances with the Federal Reserve banks are insufficient. The second type of Federal Reserve currency, the Federal Reserve Bank note, was originally intended to replace the national bank notes, but never became a permanent part of the currency because the Federal Reserve notes proved adequate. The national bank notes were retired in 1935, but greenbacks are still part of U.S. paper currency.

The Great Depression.

The economic depression and the epidemic of bank failures in the early 1930s led to sweeping reforms in the nation's monetary structure. Executive proclamations issued by President Franklin D. Roosevelt in March and April 1933 prohibited gold exports except under government license, and called in all gold and gold certificates from general circulation, thus ending the gold standard. Under the Gold Reserve Act of Jan. 30, 1934, the country returned to a modified gold standard with a devalued dollar. The act gave the president authority to lower the weight of the gold dollar to between 50 and 60 percent of its former gold content. The following day the president issued a proclamation reducing the gold content of the dollar to 59 percent of that established by the Gold Standard Act of 1900, or from 23.22 to 13.71 grains of fine gold.

The years 1933 and 1934 were also marked by important legislation regarding silver. Under the Thomas Amendment to the Emergency Farm Relief Act of May 12, 1933 (commonly known as the Inflation Act), the president was given the power to restore unlimited coinage of silver under a bimetallic system. The Silver Purchase Act, which was signed by the president on June 19, 1934, authorized the nationalization of silver and declared it to be the policy of the U.S. to have the silver holdings of the Treasury ultimately make up a maximum of one-quarter of the value of the nation's combined monetary gold and silver stocks. On Aug. 9, 1934, the president issued an executive order requiring that all silver in the U.S., with the exception of certain categories such as silver coins, fabricated silver, and silver owned by foreign governments, be delivered to the mints to be coined or held as bullion for later coinage. Under the Silver Purchase Act and subsequent legislation the Treasury purchased large quantities of silver abroad and from domestic producers, which tended to raise the price of the metal and curtail the monetary use of silver abroad, especially in China and India.

Post–World War II Developments.

Near the end of World War II most of the Allied nations joined together in a conference held at Bretton Woods, N.H., to set up a new international monetary system, replacing the international gold standard that had collapsed during the Great Depression. The conference also provided for the establishment of the INTERNATIONAL MONETARY FUND (IMF). The U.S. dollar played a key role in the new system, becoming, in effect, the world's currency. This was true, first, because all IMF members defined the value of their own currencies in terms of the dollar and, second, because the U.S. agreed to convert all dollars held by foreign governments into gold on demand and at the exchange rate agreed on when the IMF was established. Officially, this meant that the world was on a gold-exchange standard, since governments could change their currencies into gold via the U.S. dollar.

So long as the U.S. had most of the world's gold supply, as was true after World War II, this system worked fairly well. When the quantity of dollars held by foreign governments began to exceed U.S. gold holdings by large amounts, however, the system started to falter. By the early 1970s foreign government holdings of U.S. dollars were over five times greater than the U.S. gold stock. In August 1971 President Richard M. Nixon suspended gold payments of U.S. dollars. This closing of the “gold window” effectively ended all ties between the U.S. dollar and either gold or silver. Since then the U.S. has had a fully managed currency system, one with no metallic base whatsoever. U.S. citizens are free to own, buy, and sell gold, but its price is determined in the same way as any other freely traded commodity—on the basis of supply and demand. Gold no longer serves as a medium of exchange. Federal Reserve notes are overwhelmingly the dominant form of currency in circulation today.

In March 1980 the Depository Institutions Deregulation and Monetary Control Act was passed. It expanded the range of monetary instruments used by the financial community, gradually eliminated the ceiling on interest rates that savings and loan institutions are allowed to pay depositors, and made all banks subject to the reserve requirements of the Federal Reserve System by 1989.

U.S. monetary policy is carried out through commercial banks and the Federal Reserve System. Monetary policy involves action to influence the economy's performance—its output and employment level as well as the inflation rate—by controlling the money supply and the rate of interest. The Federal Reserve specifically initiates and carries out monetary policy. It is relatively easy for the Fed to increase the reserves of commercial banks, thus making possible an expansion of the money supply if businesses and individuals are willing to borrow. Still, there is no assurance that borrowing will take place, even when credit terms have eased and loans are readily available; the early 1990s provides a case in point. However, the experience of the 1970s and '80s shows that when the Fed “tightens up,” making credit more costly and loans less plentiful, the economy is affected rapidly, falling into recession with rising unemployment. This happened in 1969, 1974, and 1980–81. In the late 1970s the Federal Reserve began to “target” the money supply; that is, the Fed tried to establish a stable rate of growth for the money supply. This tactic was abandoned in mid-1982, and the Federal Reserve went back to the practice of targeting interest rates as the primary control variable.

Recent experience with policy and legislation shows that the U.S. monetary system is still evolving. Historically, the nation has gone from a wholly metallic system, when coins were the primary money in circulation, to a managed system, in which, aside from the currency in people's pockets, much of the money consists of entries in the books of banks. At the beginning of 2006, for example, the primary money supply (known as M1) totaled $1.4 trillion, of which 53 percent consisted of currency and the remaining 47 percent of demand deposits and certain other deposits, much of which came into existence through borrowing. Currency accounted for only 11 percent of M2, a much broader measure of the money supply that includes M1 plus savings deposits and small-denomination time deposits (issued in amounts of under $100,000); the total value of M2 was $6.7 trillion in early 2006. As more money is exchanged and transferred electronically, the U.S. money supply will increasingly be represented by entries in computer data banks.        D.M.J., DWIGHT M. JAFFEE, Ph.D.; rev. by W.C.P., WALLACE C. PETERSON, M.A., Ph.D.

See also COINS AND COIN COLLECTING,; CURRENCY,; DEVALUATION,; FOREIGN EXCHANGE,; INFLATION AND DEFLATION,.

For further information on this topic, see the Bibliography, sections 232. Federal Reserve System, 235. Money, 681. Coin collecting.