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Understanding Money and Its Functions

In economics, money is money in the form of coins, banknotes, bills, and other money similar to commodities. In banking and accounting, money is actual assets consisting of coins or currency equivalent which are immediately accessible or near-immediate available for use. Money acts as a medium of exchange in which goods and services can be bought and sold. While money circulates within an economy, it is considered as a liquid asset, since it can be easily transferred among individuals from one account to another without the need for a physical transaction.


Money and cash are widely used both in and out of the business world. The role of commercial banks in our everyday lives is perhaps the largest. Banks make large purchases and transfers between themselves and individuals on a daily basis. For example, a bank may transfer funds directly from one customer to another. Commercial banks also transfer cash between themselves and customers, for example, to pay for invoices that have cleared.

Aside from these regular transactions, commercial banks also undertake various activities such as saving, lending, and trading of foreign currencies. All these activities add up to a substantial amount of money being put into circulation every day. The total volume of money supply, or the total value of all currency deposits held by commercial banks, varies according to the demand for currency relative to the supply. On the supply side, deposits are used to expand the money supply when the domestic market requires a rise in the money supply, for instance, when there is a rise in prices due to excess inventory or demand.


Deferred payment transactions refer to a technique employed by some commercial banks to ensure the smooth flow of currency between bank members. Under this agreement, a certain amount of cash is paid from one member’s bank account to another’s bank account, with the stipulation that some of the money will be held in reserve and made available for use when needed by the latter bank. In theory, this guarantees that the bank will not have adequate reserves to cope with an unexpected demand for its currency.

A third category of monetary activities includes the buying and selling of securities, which include bank deposit liabilities, foreign currencies, and government bonds. A key role is played by government bonds, whose purchase is instrumental in keeping the national money supply functioned. This is facilitated by the central bank, which can purchase money as legal tender, allowing the public to buy back its money. Government deposit liabilities are usually of various types, including bank deposit liabilities and treasury bills. They are issued by the U.S. Treasury Department and are therefore legal tender. Usually, they are secured by certain assets, such as silver and gold.


In terms of money supply, it is important to realize that money is a commodity and has to be issued in sufficient quantities to facilitate both economic growth and consumption. Money, in the form of bank deposits, is granted when banks promise to pay their clients a certain amount of money in a certain period of time. When it is issued as a legal tender, this promise acts as a guarantee that the money will be repaid to the client. The money supply can be stimulated by various economic measures, including governmental deficits, increases in reserve balances and decreases in bank reserves. In addition, it may be increased by the Bank of America’s New Liberty Reserve, which purchases bank notes and coins at the specific discount rate and pays them back to customers. Such actions boost the confidence of the public regarding the safety of the money supply and help to spur the economy.

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