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Credit money is a type of currency that represents future claims for a valuable item and can be used to buy goods and services. It is made of a material with low intrinsic value and includes notes, bonds, and money market accounts. The concept originated with English goldsmiths who issued paper notes backed by precious metals. In modern monetary systems, central banks often issue fiat money that is not backed by valuable commodities. Credit money can also refer to any claim on valuable commodities used as a medium of exchange, such as checks and bonds.
Credit money refers to money that constitutes future claims for a valuable item against an entity. The owner of the money can use it to buy goods and services; Whenever the holder wishes, he can redeem it to get the item he is backed with. Credit money is made of a material that has low intrinsic value compared to the value it represents when exchanged. Some types of credit money include notes, bonds, and money market accounts. Some people also consider paper money and coins to be this type of money because they have no intrinsic value and can be exchanged for valuable commodities.
To illustrate how this concept came to be, consider English goldsmiths, who centuries ago used to keep caches of precious metals. They issued paper notes to those who deposited gold or silver for future redemption. These goldsmiths realized that they did not need to fully endorse their notes with precious metals because only a small fraction of holders return to convert their notes. The goldsmiths then issued unsecured notes as loans to people who needed funds and received profit from interest payments. These notes constituted the first form of credit money.
When a government issues banknotes, it decides on a valuable commodity in which to set them, for example gold or silver. He then fixes a stable value on the bills and establishes them as a medium of exchange. The government may choose to keep enough valuable commodities to allow everyone with tickets to redeem them. The government may also choose to keep enough of the valuable commodity to satisfy the small fraction of people who actually want to make the redemption. In this sense, the notes are credit money because people can use them to redeem gold or silver.
However, in modern monetary systems, the central bank often issues money that is not backed by valuable commodities. The size of the money supply in these systems does not depend on the availability of valuable commodities or the central bank’s obligation to repay credit money with valuable commodities. This type of money is known as fiat money and is the most ubiquitous form of money in most modern monetary systems.
Credit money can also refer to any claim on valuable commodities that is used as a medium of exchange instead of banknotes. Checks, promissory notes, and bonds that can be redeemed for bills are examples of this. Sometimes money has an expiration date, as in the case of checks in which the bank pays the recipient of the check a certain number of bills at maturity.
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