2: Understanding Money

Good morning to all of you from StockEazy financials.

In the previous topic, we had mentioned the importance of understanding one own’s self to prepare and to understand that, we had suggested the use of risk profiling. On completion of the above and stating your goals in proper financial perspective, it is very important to understand the concept of Money. Most of us, ordinary folks, use money without understanding money.

Money is what money does. We use money as a medium of exchange. One need not be an economist in a large organization, to be acutely aware that money plays an important role in modern life. Let us however look at the concept of money , it’s functions and the uses.

“Personal experience as well as knowledge of history and economics makes it clear to everyone that money plays an important role in the economic system and that the behavior of money is somehow casually related to the behavior of employment, the level of economic output , the distribution of wealth and income.“

(Reference: The economics of Money and Banking, Stephen M Goldfeld and Lester V Chandler “ninth edition Harper and Row , Publishers, New York.)

This important function is vested with the Reserve Bank of India or with the Federal reserve system in the United States of America , In India, both the actions of the above regulatory body , brings a lot of comments from various persons tracking the economic environment.

In order to participate in stock market investing , it is very important to know the functions of Money.

Money has one fundamental purpose in the economic system, which is to facilitate the exchange of goods and services, to lessen the time and effort to carry on trades and reduce the search costs. In case someone is living off the grid, he or she has no need for money. In the modern world featuring AI, specialization of persons with specific skills, the business firms in the systems and with the capital, enables us to generate huge amount of capital which is redeployed to create more gross capital in the economy. Money is thus very important to the systems of which it is a part therof. To stress this importance, let us understand the barter economy.

Barter system

Exchange of goods and services is not impossible without money. Business like this was the backbone of the Indian economy 200 years back, before the advent of money. This suffers from the following the disadvantages briefly explained below.

1) The lack of a common unit, in terms to measure and state the value of goods and services

2) The lack of double coincidence of wants.

3) The third disadvantage is the lack of any unit to write contracts requiring future payments.

4) There is a genuine lack of stored purchasing power.

These four disadvantages, require that money is required to resolve the above issues, which a barter economy suffers.

Money in the earlier era

In the year 1799 , Some thoughtful bankers in London sat together in thoughtful thinking, what should constitute money. Let us look at these bizarre forms of money in those times

Cowry shells, Porpoise teeth, Whale teeth , Boar tusks Cattle & livestock , slaves, rice, agricultural commodities, corn, wine, knives, boats, porcelain, iron, silver. Other metals , Debts of Individuals , debts of Banks , Debts of Governments.

How do Individuals interact when the exchanges did not simply match. Let us look at the functions of Money in the coming paragraphs.

The basic purpose of money is “The great wheel of circulation , the great instrument of commerce “

· Money serves as a unit of value

· Money serves as a medium of exchange

· Money serves as a standard of deferred payments

· Money serves as a unit of value

What could be covered under the definition of Money after the above points .

M0,M1, M2, M3, and M4 were the four monetary aggregates used by the RBI between 1977 and 1998 to calculate the money supply.

• Reserve Money (M0): Other names include High-Powered Money, Financial Base, Base Money, etc. M0 is calculated as follows: Money in circulation + Bankers’ deposits + Other deposits with RBI. It is the economic foundation’s currency.

• Narrow Money (M1): M1 equals money in circulation plus demand deposits in the banking system (current and savings accounts) plus additional deposits with the Reserve Bank of India (RBI).

• Narrow Money (M2): Post Office Savings, Bank Savings Deposits added to M1 equals M2.

• Broad Money (M3): M3 equals M1 plus time deposits made with banks.

• Broad Money (M4): M4 is equal to M3 plus any deposits made at post office savings banks.

When we understand the economist view about the supply of money and the various factors, we will be in a position to start our journey as an Investor on the financial highway.

Jai Hind

Seshadri Krishnaswamy Iyengar

Mentor – Stockeazy Financials