Your team could own a $9M second car and still miss Saturday's race. The pit crew can't be paid in carbon fiber. This week you learn what counts as money, and why cash is king on race day.
Learning objectives. After this week you can (1) name the three functions of money; (2) rank assets by liquidity; and (3) say what M1 and M2 measure.
Remember this: wealth is what you own. Liquidity is what you can spend today.
1) The three jobs money does
- Medium of exchange: people accept it for goods and services, so you don't have to barter.
- Unit of account: a common yardstick for prices. Every budget line is quoted in dollars.
- Store of value: it holds buying power over time, so you can save a prize check for a later race. High inflation weakens this job, because each dollar buys less as prices rise.
Barter needs a double coincidence of wants: you must find someone who has what you want and wants what you have. Money removes that problem.
2) Liquidity: how fast it turns into cash
Liquidity is how easily an asset becomes cash without losing value. Cash is perfectly liquid. A checking deposit is nearly as good. A savings deposit or a certificate of deposit (CD) takes a step. A car or a building is slow and may sell at a loss. Economists measure the money supply from the most liquid end:
M1 = currency + checkable deposits · M2 = M1 + savings and other near-money
| Asset | Liquidity | In which measure? |
|---|---|---|
| Cash | Highest | M1 |
| Checking deposit | High | M1 |
| Savings deposit | Medium | M2 (not M1) |
| Race car or garage | Low | Neither |
3) Commodity money and fiat money
Commodity money, like gold, has value of its own. Fiat money, like the dollar, has value because the government declares it legal tender and people accept it. It is not backed by gold.
Example. Your team holds $12M in cash plus a $9M second car. A rival holds $21M, all in cash. Both are worth $21M. Only the rival can spend all of it on Saturday.
Quick self-check
(a) Which is more liquid, cash or a savings deposit? (b) Your team quotes every budget in dollars. Which job is money doing? (c) Is a savings deposit part of M1? (Answers: cash; unit of account; no, it is in M2 but not M1.)
Common mistakes
- Treating wealth as cash. A fast car is wealth; it does not pay this week's bills.
- Putting savings in M1. M1 is currency and checkable deposits only.
- Thinking fiat means worthless. It has value because everyone accepts it.
This week in the arena
Open your budget panel and find your bank. It is the only money your team can spend, and there is no credit line behind it. Before you save a budget, write down how much cash will be left after this week's spend. That leftover is your liquidity for the next race.