A Medium of Exchange

The 1st Job-to-be-done with money

A medium of exchange is an intermediary instrument or system used to facilitate sale, purchase, or trade of goods between parties. For a system to function as a medium of exchange, it must represent a standard of value. Further, all parties must accept that standard. In modern economies, the medium of exchange is currency.

Using a medium of exchange allows for greater efficiency in an economy and stimulates an increase in overall trading activity. In a traditional barter system, trade between two parties can only happen if one party has a commodity that another party desires, and vice versa. The chance of this happening simultaneously as a cross occurrence — where each party desires something that the other party has — is improbable.

Thankfully, with a medium of exchange, such as gold, if one party had a cow and happened to be in the market for a lawnmower, the cow owner could sell their animal for gold coins, which they may, in turn, use to purchase the lawnmower.

The international gold standard emerged in 1871, following its adoption by Germany. By 1900, the majority of the developed nations were linked to the gold standard.

Money enables anyone who possesses it to participate as an equal market player. When consumers use money to purchase an item or service, they are effectively making a bid in response to an asking price. This interaction creates order and predictability in the marketplace. Producers know what to produce and how much to charge, while consumers can reliably plan their budgets around predictable and stable pricing models.

If money — as represented by a currency — is no longer viable as a medium of exchange, or if its monetary units can no longer be accurately valued, consumers lose their ability to plan budgets. Additionally, there is no longer a way to gauge supply and demand accurately. In short, market volatility will cause the markets to become chaotic.

Prices are bid up or raised, in response to worries about scarcity and fears of the unknown. Meanwhile, supply diminishes because of hoarding behaviors, coupled with an inability of producers to quickly replenish inventory.

Alternative currencies have appeared throughout time during periods of economic duress to spur commerce or buttress a national currency. In the early 20th century, the U.S. companies had to issue company scrip and other forms of emergency currency in order to pay their workers. At the time, massive bank failures had caused widespread cash shortages. Workers could redeem the scrip for food and services, or they could hold onto it for future redemption once U.S. dollars became available.

Fiat money is money that does not have intrinsic value and does not represent an asset in a vault somewhere. Its value comes from being declared "legal tender" - an acceptable form of payment by the government of the issuing country.

Gold, fiat money, and scrip mentioned in this chapter are all examples of mediums of exchange.