EVOLUTION OF MONEY/ PAYMENTS SYSTEM

Payment system: the method of conducting transactions in the economy. The payments system has been
evolving over centuries, and with it the form of money. At one point, precious metals such as gold were used as
the principal means of payment and were the main form of money. Later, paper assets such as checks and
currency began to be used in the payments system and viewed as money.
Money was developed according to needs & Requirements. Main aim was to remove the shortcomings of the
Barter System.
5. DIFFERENT STAGES OF EVOLUTION OF MONEY 1. COMMODITY MONEY 2. METALIC MONEY
3. PAPER MONEY 4. CREDIT MONEY 5. ELECTRONIC MONEY

COMMODITY MONEY
 In ancient times, barter system was mostly prevailed in the world.
 During the period of early human civilization, any commodity that was demanded and chosen by
common consent was used as a form of currency.
 Goods like furs, salt, rice, wheat, weapons, animals, and much more were used as an exchange
 This system started creating difficulties in trade as barter trade cannot be done between two individuals
if one has need for something that another have but the latter individual has no need of something that
former is offering.
 For eg: There are two farmers named A and B. A is growing wheat and B is growing rice. A needs rice
and he is offering wheat to B but B has no need of wheat which is offered by A and, that’s why, B didn’t
accepted the offer given by A. So, there cannot be exchange between A and B.
 Thus, common things like shells, pebbles, salt, came into existence as common goods used for
exchange. Now A can sell his wheat to C and, in return, he gets shells as money and, with this, he can
buy rice from B and thus, his needs could be fulfilled easily through money. This was the birth of money
and ancient economy started to develop.
Problem
As people started using commodity as a money, new problems came into being. Commodity money had three
common defects
Perishability: They were perishable so they couldn’t be kept for a long time and so, people couldn’t repay their
loans or they cannot save it for future needs.
Indivisibility: It was hardly divisible as commodities like cows, etc are useless if divided. So, it was difficult to
buy a product in a value which is half of currency’s value.
Heterogeneity: Different commodities were used in different markets or cities as a currency, that’s why,
intercity trade was almost impossible. For eg: A lives in city X and B lives in city Y. A cannot trade with B
because the city X accepts shells for currency and city Y accepts cattle as a currency.
METALLIC MONEY
 “Metallic Money consist of coins made of Gold, Silver, Copper or nickel as a mode of payment.”
 Metals like gold, silver, copper, nickel, and much more were used as they could be easily handled and
their quantity can be readily ascertained.
 Un Coined Metals: Metals were not used as a coin but as a Bullion.
  This created the problem of measuring the weight & Value.
 Supply of money also became problem when the mines were fully used up or new mines were
discovered.
 Coined Metals: As a next step, standard coins were created.
 They had a standard weight & value.
 Different metals to indicate different values – gold coins were used for highest valuable goods and
so, it can be divided into smaller values by exchanging gold coin for two silver or three bronze coins
which have value smaller than gold coin. Coins were acceptable for more than one cities, so A can
trade with B as cities X and Y have accepted same metallic currency system.
 METALLIC MONEY Metallic money can be:
 Fully Bodied Whose Face Value is equal to the value of metal contained in it.
 Token Money Its Face Value is Higher than Intrinsic Value (Value of Metal)
Problems
 very heavy
 Hard to transport from one place to another, especially for large purchases.
As people started using metallic money, it was hardly portable. As trade and commerce increased, people
started becoming rich but it was virtually impossible to possess vast amount of coins as they were very heavy
and bulky

PAPER MONEY
PAPER MONEY: Refers to the Notes issued by the State or by the Bank, usually the Central bank.
 Paper Money can be:
1. Representative Paper Money: It is that money which is fully backed by equivalent metallic reserves
2. Convertible Paper Money: Money Which is convertible into coins on demand
3. Fait Paper Money: Which is not redeemable or convertible into Gold or Silver on demand. It is
accepted because it is declared legal tender by the issuing authority and has general acceptance as a
medium of exchange. The intrinsic value of Fait money is Nil.
Fiat money, paper currency decreed by governments as legal tender (meaning that legally it must be
accepted as payment for debts) but not convertible into coins or precious metal. Paper currency has the
advantage of being much lighter than coins or precious metal, but it can be accepted as a medium of
exchange only if there is some trust in the authorities who issue it and if printing has reached a
sufficiently advanced stage that counterfeiting is extremely difficult. Because paper currency has
evolved into a legal arrangement, countries can change the currency they use at will. Indeed, this is what
many European countries did when they abandoned their currencies for the euro in 2002. Major
drawbacks of paper currency and coins are that they are easily stolen and can be expensive to transport
in large amounts because of their bulk.
CHECKS
 A check is an instruction from you to your bank to transfer money from your account to someone else’s
account when she deposits the check.
 Checks allow transactions to take place without the need to carry around large amounts of currency.
 The introduction of checks was a major innovation that improved the efficiency of the payments system.
Advantages:
 The use of checks reduces the transportation costs associated with the payments system and improves
economic efficiency.
 Minimize the movement of money, payments that cancel each other can be settled by canceling the
checks.
 Another advantage of checks is that they can be written for any amount up to the balance in the account,
making transactions for large amounts much easier.
 Checks are also advantageous in that loss from theft is greatly reduced and because they provide
convenient receipts for purchases.
Problems
 It takes time to get checks from one place to another, a particularly serious problem if you are paying
someone in a different location who needs to be paid quickly.
 In addition, if you have a checking account, you know that it often takes several business days before a
bank will allow you to make use of the funds from a check you have deposited. If your need for cash is
urgent, this feature of paying by check can be frustrating.
 Second, the paper shuffling required to process checks is costly; currently, the cost of processing all
checks written in the United States is estimated at over $10 billion per year
Electronic Money
 Electronic money (also known as e-money, electronic cash, electronic currency, digital money, digital
cash or digital currency) refers to money or scrip which is exchanged only electronically.
 Typically, this involves use of computer networks, the internet and digital stored value systems.
 In the past, you had to pay bills by mailing a check, but now banks provide websites at which you just
log on, make a few clicks, and thereby transmit your payment electronically.
 Not only do you save the cost of the stamp, but paying bills becomes (almost) a pleasure, requiring little
effort.
 Electronic payment systems provided by banks now even spare you the step of logging on to pay the
bill. Instead, recurring bills can be automatically deducted from your bank account.
 Estimated cost savings when a bill is paid electronically rather than by a check exceed one dollar per
transaction. Electronic payment is thus becoming far more common in the United States.
E-Money
 Electronic payments technology can substitute not only for checks but also for cash, in the form of
electronic money (or e-money)—money that exists only in electronic form.
 The first form of e-money was the debit card. Debit cards, which look like credit cards, enable
consumers to purchase goods and services by electronically transferring funds directly from their bank
accounts to a merchant’s account. Debit cards are used in many of the same places that accept credit
cards and are now often becoming faster to use than cash. At most supermarkets, for example, you can
swipe your debit card through the card reader at the checkout station, press a button, and the amount of
your purchases is deducted from your bank account. Most banks and companies such as Visa and
MasterCard issue debit cards, and your ATM card typically can function as a debit card.
 A more advanced form of e-money is the stored-value card. The simplest form of stored-value card is
purchased for a preset dollar amount that the consumer pays up front, like a prepaid phone card. The
more sophisticated stored-value card is known as a smart card. It contains a computer chip that allows it
 to be loaded with digital cash from the owner’s bank account whenever needed. In Asian countries, such
as Japan and Korea, cell phones now have a smart card feature that raises the expression “pay by phone”
to a new level. Smart cards can be loaded from ATM machines, personal computers with a smart card
reader, or specially equipped telephones.
 A third form of electronic money is often referred to as e-cash, which is used on the Internet to purchase
goods or services. A consumer gets e-cash by setting up an account with a bank that has links to the
Internet and then has the e-cash transferred to her PC. When she wants to buy something with e-cash,
she surfs to a store on the Web and clicks the “buy” option for a particular item, whereupon the e-cash is
automatically transferred from her computer to the merchant’s computer. The merchant can then have
the funds transferred from the consumer’s bank account to his before the goods are shipped.
 Given the convenience of e-money, you might think that we would move quickly to a cashless society
in which all payments are made electronically.

Measuring Money
 The definition of money as anything that is generally accepted in payment for goods and services tells us
that money is defined by people’s behavior.
 What makes an asset money is that people believe it will be accepted by others when making payment.
As we have seen, many different assets have performed this role over the centuries, ranging from gold to
paper currency to checking accounts.
 To measure money, we need a precise definition that tells us exactly which assets should be included.
The Federal Reserve’s Monetary Aggregates
 The Federal Reserve System (the Fed), the central banking authority responsible for monetary policy has
conducted many studies on how to measure money.
 The problem of measuring money has recently become especially crucial because extensive financial
innovation has produced new types of assets that might properly belong in a measure of money.
 Since 1980, the Fed has modified its measures of money several times and has settled on the following
measures of the money supply, which are also referred to as monetary aggregates.

Monetary Base (The Narrowest Measure of money)

Quantity of government produced money.
It includes currency and reserves of depositary institutions
M1: The narrowest measure of money that the Fed reports is M1, which includes the most liquid assets:
o Currency
o checking account deposits
o Traveler’s checks.
 The currency component of M1 includes only paper money and coins in the hands of the nonbank public
and does not include cash held in ATMs or bank vaults.
 The traveler’s checks component of M1 includes only traveler’s checks not issued by banks.
 The demand deposits component includes business checking accounts that do not pay interest, as well as
traveler’s checks issued by banks.
 The other checkable deposits item includes all other checkable deposits, particularly interest-bearing
checking accounts held by households. These assets are clearly money because they can be used directly
as a medium of exchange.
  Until the mid-1970s, only commercial banks were permitted to establish checking accounts, and they
were not allowed to pay interest on them. With the financial innovation that has occurred regulations
have changed so that other types of banks, such as savings and loan associations, mutual savings banks,
and credit unions, can also offer checking accounts. In addition, banking institutions can offer other
checkable deposits, such as NOW (negotiated order of withdrawal) accounts and ATS (automatic
transfer from savings) accounts, which do pay interest on their balances

M2: The M2 monetary aggregate adds to M1 other assets that are not quite as liquid as those included in M1

 Saving and small-denomination time deposits

 Overnight repurchase agreement (RPs) at commercial banks.
 Balances in money market mutual funds
 Money market deposit accounts.

Assets that have check-writing features (money market deposit accounts and money market mutual
fund shares) and other assets (savings deposits and small-denomination time deposits) that can be
turned into cash quickly at very little cost. Small-denomination time deposits are certificates of deposit
with a denomination of less than $100,000 that can be redeemed only at a fixed maturity date without a
penalty. Savings deposits are no transaction deposits that can be added to or taken out at any time.
Money market deposit accounts are similar to money market mutual funds, but are issued by banks.
The money market mutual fund shares are retail accounts on which households can write checks.

M3: The M3 monetary aggregate (broader definition of money) adds to M2 and other assets

 large -denomination time deposits

 Term Repurchase agreements at CB, SB and ssaving and Loans Associations.
 Balances in money market mutual funds
 Money market deposit accounts.

Assets that have check-writing features (money market deposit accounts and money market mutual fund
shares) and other assets (savings deposits and small-denomination time deposits) that can be turned into
cash quickly at very little cost. Small-denomination time deposits are certificates of deposit with a
denomination of less than $100,000 that can be redeemed only at a fixed maturity date without a
penalty. Savings deposits are nontransaction deposits that can be added to or taken out at any time.
Money market deposit accounts are similar to money market mutual funds, but are issued by banks. The
money market mutual fund shares are retail accounts on which households can write checks.