QandAs: Finance

What Is Currency?

Answer:
Currency can refer either to a particular currency, such as the Euro, or to the collective coins and paper money which make up a country’s money supply.

Money deposited into banks makes up the other part of the money supply, and this money can be transferred using checks or electronic transfers. Deposits and currency are both money because they are both acceptable for payments, but money is not necessarily currency.

Money in the form of currency has dominated over time. In the past, gold or silver coins with an underlying value have been the norm. However, modern currency, or fiat money, is essentially worthless other than the value that is stamped on it. For example, if a one ounce silver coin has a value stamped on it and the issuing government goes under, the coin will still be worth the value of an ounce of silver. In contrast, if you have a twenty dollar bill and the issuing government goes under, all you have is a pretty piece of paper (think Confederate money).

In each country, a central bank will have total control over the production of that country’s currency. Trade between countries is made possible through the use of exchange rates, which is the price at which trade can occur between countries. Depending on the exchange rate regime, each currency can be classified as a floating currency or a fixed currency.

Within a country, control of the currency is through a central bank or through a Ministry of Finance. In either situation, the institution is referred to as the monetary authority. The government will allow them to have varying levels of control. In almost every western country, the monetary policy is independent from government control.

Several countries use the same name for their currencies, although they are independent of each other. Additionally, multiple countries can use the same currency (Euro), and a country can also declare another country’s currency legal tender in its own. For example, Spanish silver coins were legal tender in the United States from 1791 to 1857. Each currency has a main currency (such as the dollar) and a fractional currency. Mauritania and Madagascar are the only two countries that do not use the decimal system in their currency.