Why does commodity money have value?
The value of fiat money is based largely on public faith in the issuer. Commodity money's value, on the other hand, is based on the material it was manufactured with, such as gold or silver. Fiat money, therefore, does not have intrinsic value, while commodity money often does.
Early forms of money were often commodity money-money that had value because it was made of a substance that had value. Examples of commodity money are gold and silver coins.
This ultimately implies that, commodity money has value based on the type of material that was used to make it. Some examples of commodity money are gold, diamonds, silver, cowry, cocoa, copper, and other valuable resources.
Commodity money has intrinsic value because it has other uses besides being a medium of exchange. Fiat money serves only as a medium of exchange, because its use as such is authorized by the government; it has no intrinsic value.
How can commodity money provide a measure of value? Commodity money provides a measure to value other goods and services. One service might be worth one pound of tobacco, while another service might be worth more or less.
The most common store of value in modern times has been money, currency, or a commodity like a precious metal or financial capital.
The real value is obtained by removing the effect of price level changes from the nominal value of the data of goods, service or time series to get a more accurate picture of economic trends.
The primary advantage of commodity money is that commodities tend to have greater intrinsic value. Further, because of this intrinsic value, commodity money is not as susceptible to inflation as fiat money is. Finally, commodity money may be less susceptible to government regulation.
Commodity money is also know as standard money because it is the monetary unit which is approved by the government to act as the legal tender in the currency system and in which other types of money in the economy like bank draft, promissory not etc. is convertible.
The Federal Reserve notes used in the United States today are an example of fiat money. The money is not backed by gold or any other commodity which the government holds in its vaults and the paper upon which the notes are printed is worth very little.
What is the difference between money value and commodity value of money?
Thus, money value of a paper note is what is written on it, i.e. Rs 100, Rs 500, etc. You can buy goods and services worth of that amount in the market. Commodity value of money refers to value of the material out of which coins or currency notes are made.
One of the major problems with commodity money was quality. Individuals tended to use or sell their best products while their poorest products would be offered as commodity money. Additionally, even good quality commodities would deteriorate if retained too long.
Historically, examples of commodity money include gold, silver, tea, alcohol, and seashells. Even if no one would accept such goods as trade, the owners could still use them for their purposes.
The gold standard was abandoned due to its propensity for volatility, as well as the constraints it imposed on governments: by retaining a fixed exchange rate, governments were hamstrung in engaging in expansionary policies to, for example, reduce unemployment during economic recessions.
Commodity money is a medium of exchange that may become (or be transformed into) a commodity, useful in production or consumption. This is in contrast to fiat money, which is intrinsically useless.
Fiat money is a government-issued currency that is not backed by a commodity such as gold. Fiat money gives central banks greater control over the economy because they can control how much money is printed. Most modern paper currencies, such as the U.S. dollar, are fiat currencies.
Examples of Commodity Money
Precious metals and coinage: Precious metals, such as silver, gold, platinum, and copper, have been used since ancient times as commodity money. Ancient coins were made of gold, silver, or other metals.
Prior to 1971, the US dollar was backed by gold. Today, the dollar is backed by 2 things: the government's ability to generate revenues (via debt or taxes), and its authority to compel economic participants to transact in dollars.
| Pros | Cons |
|---|---|
| Can generate short-term profits | Extreme volatility |
| A hedge against inflation | Long periods of declining prices |
| Diversification benefits | Holding physical commodities may incur storage fees |
| Commodities don't generate income for investors |
Fiat money is backed by a country's government rather than by a physical commodity or financial instrument. Most coin and paper currencies that are used throughout the world are fiat money. This includes the U.S. dollar, the British pound, the Indian rupee, and the euro.
Why does United States currency have value?
The dollar's value comes from the US' position as a critical global economic power and the country's political and economic stability. While it may hold less value than such currencies as the Swiss franc or the British pound, the dollar's global use makes it a more commercially viable currency.
Cigarettes and gasoline were used as a form of commodity money in some parts of Europe, including Germany, France and Belgium, in the immediate aftermath of World War II.
Long ago, people in the U.S. used commodity goods such as salt and rice as money. Because these items weren't always easy to carry and could go bad after a while, we eventually changed to using coins, made of precious metals.
In the foreign exchange market, commodity currencies generally refer to the New Zealand dollar, Norwegian krone, South African rand, Brazilian real, Russian ruble and the Chilean peso.
The Great Seal of the United States, featuring an eagle and shield, is printed in purple to the right of the portrait of President Lincoln. An arc of purple stars surrounds the portrait and The Great Seal. A large purple numeral 5 on the back of the note helps those with visual impairments distinguish the denomination.
