Most of us use money on a daily basis, whether it’s to buy things, get paid, or transfer money to a friend. Through the ages, money has taken various forms – from gold and silver through to the two types of money used today: cash and bank deposits.
What is money?
What can you do with money?
The most obvious ‘function’ of money is simple: it makes it easy for people to buy and sell things. It is seen as a reliable ‘medium of exchange’ between buyer and seller. For this reason alone money is considered central to the workings of the modern economy.
But money has other uses, too. It is a way to store value for the future. For instance, if you were given an ice cream worth £2, you could enjoy it right now, but if you didn’t it would melt – and that ‘value’ would disappear. But if you were given £2 instead, you could spend it any time you like.
Money is also used when businesses price things. If you get your car fixed by a mechanic, you’ll be charged in pounds and pence. The price could be listed in other units (bags of rice, pints of milk, etc) but money offers a shared standard that everyone can use, making it easy to compare prices.
What’s the difference between commodity and fiat money?
Historically, as trade increased through the centuries, commodity money such as gold and silver was used in most countries. In the 16th century, goldsmiths began storing gold coins for customers and issuing them with receipts, which could be converted back into gold on demand.
Carrying precious metals around is a considerable physical burden, though. Over time, people started to use the receipts given to them by goldsmiths instead. In other words, these receipts became a form of money themselves – and forerunners of the banknotes used today.
The Bank of England – the UK’s central bank – has been issuing banknotes for more than 300 years. For most of that time, banknotes could be exchanged, on demand, for the equivalent amount of gold. But the link between banknotes and gold, known as the Gold Standard, finally ended in 1931. Since then, banknotes have been a form of fiat money: money that is not convertible to gold or any other asset.
Why do people use banknotes as money today?
One advantage of a system that uses fiat money is that the amount of money in circulation can be responsive to changing economic conditions. This can support the smooth functioning of the economy. By contrast, the total amount of money circulating in the economy during the Gold Standard was ultimately limited by the amount of gold that could be mined.
Today, we promise to honour the value of our banknotes for all time, even for banknotes that are no longer in use. For example, following the introduction of the new polymer £5 note in 2016, the old paper £5 notes were taken out of circulation in May 2017. However, all withdrawn Bank of England notes remain payable at face value. So if you have a paper £5 note today, you can still exchange it by post or in person at the Bank of England for a new (polymer) banknote. And crucially, you will always be able to do so.
As another guide explains, you can think of a banknote as a universally accepted ‘I owe you’ (IOU) – hence the ‘promise to pay’ inscription:
The ‘promise to pay’ inscription on a banknote
Crucially, people trust that the value of money will endure over time. We are responsible for making sure that the value of your money stays broadly stable (this guide explains more) and that our banknotes have state-of-the-art security features. Trust in fiat money is also supported by the Government deeming banknotes as a legally valid means of settling debts: our guide on ‘legal tender’ explains more.
What are the physical and electronic forms of money today?
Today, cash and bank deposits are the two main forms of money. The vast majority of all money in the UK is held electronically as deposits, with just a small proportion held in physical form as cash (banknotes and coins).
Money held by households and companies in the UK:
People deposit money in banks in part for security reasons, because holding large amounts of cash is risky as it could get lost or stolen. However, cash continues to be important. In fact, there is more cash today than ever before: there are over £70 billion worth of banknotes in circulation, equivalent to around £1000 per person in the UK.
Find out more
- This Bank of England article provides a more detailed overview of money in the modern economy. Useful resources are also available at ecnmy.org.
- Other Bank of England articles discuss the future of cash and the status of local currencies and digital currencies (like Bitcoin) as money. Money is also a subject of debate on Bank Underground, the Bank of England staff blog.
- Find out more about the polymer £5 note featuring Winston Churchill and the £10 note featuring Jane Austen, which will enter circulation on 14th September 2017.