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Standard of deferred payment and legal tender

A fourth function of money is that anytime you take on a debt, when the time comes to repay it, you can use money. This is highly related to the idea of "legal tender", which you can also learn about in this video. Created by Grant Sanderson.

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  • duskpin ultimate style avatar for user Ahmad Ghaemi
    Why would one want to have a system with legal tender if it means you can pay back your loan in the exact same amount of currency even though it has devalued? I didn't quite get this video. The others have been great though!:-) Thanks.
    (5 votes)
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    • ohnoes default style avatar for user Tejas
      It's great for borrowers, and not so great for investors. However, neither really matter. It is really good for governments, because they can essentially force people to use the currency that they want and use that to control the economy.
      (4 votes)
  • stelly green style avatar for user asiyah.karim599
    Why might a business that sells goods on credit use money as a standard of deferred payment?
    (2 votes)
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    • duskpin sapling style avatar for user asiyah2053
      A business that sells goods on credit might use money as standard of deferred payment because a customer may not have the amount of money to pay for his/her goods at the moment so he/she can acquire their goods now and pay for it at a later date
      (2 votes)
  • mr pink red style avatar for user doctor_luvtub
    Why do gold coins have such a lower face value than the value of the gold from which they're made? (For example, a 1 oz American Eagle has a face value of $50, but the gold is worth more than 20 times that amount.) Is it to discourage use of gold as a medium of exchange?
    (2 votes)
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Video transcript

- [Voiceover] Hi everyone, so in the last couple of videos I was talking about various functions of money, and people usually list at least three different functions that it serves. The first is a medium of exchange, it's what we use to trade for goods. The second is that it's a store of value, if you keep your money around it'll retain its value. And the third is that it's a unit of value, we usually think of things in, you know, dollar terms, or euro or peso or yen terms. And some texts will actually add a fourth function of money onto this, which is that money is the standard of deferred payment, standard of deferred payment. Now what does this mean, what does deferred payment mean? Basically it's anytime that you receive something, but only pay for it later, and the most common form of this is debt. So let's say that you, you're over here and you want to borrow $1,000. So you borrow $1,000, maybe it's from some kind of institution like a bank, and maybe it's a, let's say it's a $1,000 credit card loan, so you receive it, and then some kind of time passes, maybe it's like the month, before your credit card bill comes, some time passes, and then after that, you repay that debt, and you'll repay it with money. And this is probably the most common way you're receiving, you know, money to use for something and then you pay it back, but there are other forms of deferred payment, like if you go to a restaurant, for example, where you receive your food before you pay your bill at the end. That would actually be a form of a deferred payment, because, you know, you receive your food at the start of the evening, and then you eat it, and it's only at the end that you pay it, hopefully, your bill isn't $1,000, but it is something where you're paying it at the end. And, in so far as money is what we use to repay this, this is its fourth function. And now you might be able to see why some people think that this shouldn't count as an extra one, because you could argue, that this falls under the category of a medium of exchange, you know, just in the same way that you use money to buy a chair or to buy legal services or to buy food, you're using money to pay your debt, it's just another one of those things that you're exchanging for, so why should this be separated? Well, one case that you could make for why this idea of a standard of deferred payment really does serve a different function than the others is that at least in modern economies, there's somewhat of a legal backing to the idea of money serving this standard. And by that, I mean, if you take on a debt, in a country, and there's some kind of legal obligation attached to that debt, associated with the legal system of the country, tied into the law is the idea that you can pay back that debt with money, and if you've ever heard the term legal tender, legal tender, this is what it's referring to. So legal tender, so you might have heard of, like, dollar bills, or coins, and things like that being called legal tender, and what this means, so legal, indicates that there's some association with the system of law within a given country, and tender, tender is kind of an old word for offer. And what this basically means is that if you take on a debt, like, you know, you borrow $1,000 from the bank, or you, you know, eat food in a restaurant before you pay for it, as soon as you offer money, as soon as you offer something which is legal tender, so like dollar bills, that debt will no longer exist. The act of offering it alone will eliminate that debt. And just as an example of why this has some bearing, consider the fact that it used to be the case people would often take out loans in gold. Like in the late 1800s, for example, when a lot of railroads were being built and there was debt being raised to support the building of those, it would often be the case that one of the men building these railroads might borrow a large sum of money, but he would borrow it in the form of a lot of gold, some kind of gold. And then it was expected that he could pay this back, you know, in that same form, he could pay back the gold itself. You know, maybe plus interest, this is why people were giving him gold in the first place, and it might be, you know, maybe, it's just a lot of people looking to invest the gold that they're holding and hoping that it returns some kind of interest. Now let's think about what would happen if you tried to do this today, where for instead of, you know back in the era, you were doing this today. So let's say you borrowed like one ounce of gold, so it might be one ounce of gold. And say that corresponded today, to $1,000, if it was $1,000 for every ounce of gold. Then let's say while you're holding onto it, you know some time passes, you're investing in, maybe instead of building railroads, you're doing something more modern with it, but let's say after enough time has passed, the gold has actually gone up in value, you know, maybe there's been inflation or maybe for whatever reason the gold is now a higher price, and instead, instead let's say after the time, it's now $2,000, $2,000 for a single ounce of gold. Now if you were to pay back exactly what you received, you would pay back one ounce of gold, maybe plus some interest, and nobody would have any reason to complain. However, legally, you're allowed to pay back your debt in the form of the legal tender of the country, so for example in the United States, since your original loan was in the form of $1,000, you could pay back, instead of in gold, $1,000, just US dollars, and just by offering that to the people who originally gave you the loan, the debt would be gone, but in effect what this would mean, is that you're paying back half an ounce of gold, because after this time has passed, you know, the dollar has devalued relative to gold, and instead, $1,000 would only buy half an ounce of gold, and you might imagine people would be kind of unhappy about that. So the whole point here, is that the standard of deferred payment actually has some legal clout to it, so what could, well you could argue separates it from the other functions of money, is this fact that the currency in most modern economies is actually tied up with the legal system of the associated country. So with that, I will see you next video.