What money is: unit of account, medium of exchange, store of value

Ask ten people what money is and most will point at the thing in their wallet or the number in their banking app. That answer confuses money with one of its containers. Money is not a substance. It is a set of three jobs that a society needs done, and the objects we call money are whatever happens, at a given time and place, to do those jobs well enough.

The three jobs are: providing a unit in which prices are quoted and debts are written, providing an instrument that settles a transaction so no one is left owed anything, and providing a way to carry purchasing power from now into later. They are related but genuinely separate, and the interesting things in monetary economics happen when one of them fails while the others hold. Understanding which job is failing tells you what will happen next to interest rates, to the currency, and to the price of what you own.

Unit of account: the measuring stick nobody notices

The unit of account is the least glamorous function and by far the stickiest. It is the scale in which prices are expressed and contracts are written. In Switzerland it is the franc: your rent, your salary, your mortgage principal, your insurance payout and your tax bill are all denominated in it.

The value of a unit of account comes from coordination, not from any intrinsic property. A price is only informative if the buyer and seller use the same measuring stick. If a coffee costs CHF 5.00 and a decent commuter bike costs CHF 1,200, the unit tells you the bike is worth 240 coffees. That comparison — the relative price — is the real economic information. The franc is just the medium through which it is expressed.

Two consequences follow, and both matter for investing.

First, because the unit is a coordination device, it changes only rarely and usually only under duress. Countries abandon their own unit of account during hyperinflations or when they join a currency union, not because a better one appeared. The euro replaced eleven national units in 1999 through a deliberate, decade-long legal and political process, and even then the physical notes only arrived in 2002. Inertia in the unit of account is a feature.

Second, contracts written in a unit are nominal. Your mortgage says you owe a number of francs, not a quantity of purchasing power. This is the single most important asymmetry in personal finance: inflation transfers wealth from creditors to debtors because the debt is fixed in the unit while the price level moves. A Swiss household with a CHF 600,000 mortgage and a fixed rate is short the franc in real terms. That position pays off in inflation and hurts in deflation, whatever the household thinks it is doing.

Medium of exchange: solving the double coincidence problem

The medium of exchange function exists to eliminate what economists call the double coincidence of wants. Under pure barter, a dentist who wants a haircut must find a hairdresser with toothache. The search cost of matching is what makes barter economies small.

Money removes the search problem by being universally acceptable. The mechanism is self-referential and worth stating precisely: you accept francs not because you want francs, but because you are confident the next person will accept them from you. Acceptability is an equilibrium sustained by expectation. That is why monetary systems can be extremely stable for decades and then collapse quickly — the belief that supports them is common knowledge, and common knowledge can flip.

Legal tender status helps but does not do the work by itself. In Switzerland, banknotes issued by the Swiss National Bank and coins issued by the Confederation are legal tender, which means a creditor must accept them in settlement of a franc debt. Yet the overwhelming majority of Swiss payments by value never touch a banknote. They are settled by transferring commercial bank deposits — through TWINT, cards, direct debits or standing orders. Those deposits are not central bank money at all. They are the unsecured liability of a private bank, and you hold them because you trust the bank and the supervisory apparatus behind it.

This is the point most people miss. What circulates as everyday money in a modern economy is mostly private credit that is convertible one-for-one into public money on demand. The convertibility is what makes the two feel identical. Deposit insurance — in Switzerland, esisuisse protects privileged deposits up to CHF 100,000 per depositor per bank — exists to keep that one-for-one belief intact for small savers. A bank run is precisely the moment when depositors stop believing a franc of deposit equals a franc of cash. The next lesson in this course, on money creation by commercial banks, takes the mechanism apart in detail.

Settlement matters as much as the instrument. A payment is final when the recipient has an unconditional claim that cannot be reversed. Card payments and direct debits are provisional for days; a transfer over the Swiss Interbank Clearing system, settled in central bank money, is final in real time. When you read that a new payment technology is "instant", the question to ask is not how fast the screen updates but at what moment settlement becomes irrevocable and who bears the risk in between.

Store of value: carrying purchasing power forward

The third job is to move purchasing power across time. Money does this badly compared with productive assets, and that is not a defect of the design — it is the price of liquidity.

The arithmetic is unforgiving. Suppose you hold CHF 10,000 in a non-interest-bearing account for ten years. At 1% average inflation, roughly the mid-range of what Switzerland has experienced over long stretches, the real value at the end is 10,000 ÷ 1.01¹⁰ = 10,000 ÷ 1.1046, or about CHF 9,053. You lose about 9.5% of purchasing power without a single bad decision. At 2% inflation — the top of the SNB's definition of price stability — the same balance is worth 10,000 ÷ 1.2190, about CHF 8,203. At 5%, it is 10,000 ÷ 1.6289, about CHF 6,140. The loss is not linear, because compounding is not linear, and this is why the difference between a 2% and a 5% inflation regime is far larger than the three-percentage-point gap suggests.

Switzerland has historically had lower and less volatile inflation than most peers, which is one reason the franc functions well as a store of value and why it attracts flows in crises. But "better than the alternatives" is not the same as "preserves value". Cash is a depreciating asset in any positive-inflation regime by construction.

Two Swiss-specific frictions sharpen the point. Interest credited on a Swiss bank account is subject to 35% federal withholding tax (Verrechnungssteuer) at source, reclaimable through your tax return if you declare the income properly — so the headline rate on a savings account is not what lands in your pocket until you reclaim it. And Swiss wealth tax, levied by cantons and communes, applies to the balance itself, not to the return on it. In a low-rate environment a cash balance can plausibly yield less than the wealth tax charged on holding it, which makes the real, after-tax return on idle francs negative even before inflation.

Where the three functions come apart

The functions travel together in a healthy monetary system and separate under stress. Watching them separate is diagnostic.

In a high inflation, the store-of-value function fails first. People still quote prices in the domestic unit and still transact in it, but they hold savings in something else — foreign currency, property, durable goods. In a severe inflation the unit of account goes next: shops begin quoting in dollars or euros and converting at the door. This is dollarisation, and it is usually irreversible for a long time, because once the population has coordinated on a new measuring stick, coordinating back is hard.

The reverse pattern also occurs. An asset can be an excellent store of value and a poor medium of exchange. Gold has held purchasing power over very long horizons but nobody settles a grocery bill with it, because it is costly to assay, transport and divide. Highly volatile assets face the opposite obstacle: they cannot serve as a unit of account, because a measuring stick that changes length daily makes contracts unwritable. This is the durable structural objection to volatile crypto assets as money, and it is separate from any view on whether they are good investments. Stablecoins are an attempt to import an existing unit of account rather than create one, which is a tacit admission that the unit-of-account job is the hardest of the three.

What backs the franc

Modern money is fiat money: it is not redeemable for a fixed quantity of anything. Switzerland formally severed the franc's link to gold in 2000, when the revised Federal Constitution took effect and the new Federal Act on Currency and Payment Instruments removed the gold parity; the National Bank Act itself was rewritten three years later. What replaced the gold link was not nothing. It was an institutional commitment.

The SNB's mandate, set out in the Federal Constitution and the National Bank Act, is to ensure price stability while taking due account of economic developments. The SNB interprets price stability as a rise in the Swiss consumer price index of less than 2% per year, deflation included as a failure. Behind that sits central bank independence, a balance sheet of real assets, and the state's power to demand francs in taxation.

So the answer to "what backs the franc" is: a credible policy commitment, enforced by an institution that can withdraw francs from circulation as readily as it creates them, in a jurisdiction whose fiscal position and legal system make that commitment believable. Currencies fail when one of those conditions fails — most often when a government captures the central bank to finance a deficit. The later lessons in this course on the SNB's mandate and on central bank independence deal with how that constraint is built and how it is defended.

What to take away

• Money is defined by three jobs — unit of account, medium of exchange, store of value — and any given asset can perform one of them well while failing the others; diagnosing which function is under stress tells you what is actually happening in a monetary crisis.
• The unit of account is the stickiest function and the reason nominal debt is a real economic position: a fixed-rate mortgage is a short position in the franc that gains from inflation and loses from deflation, regardless of the borrower's intent.
• Almost all Swiss payment volume settles in commercial bank deposits, which are private liabilities convertible into central bank money on demand; deposit insurance and supervision exist to protect that one-for-one belief, and a bank run is what it looks like when the belief breaks.
• Cash loses real value by construction: CHF 10,000 held for a decade at 2% inflation is worth about CHF 8,200 in today's purchasing power, and Swiss wealth tax plus 35% withholding tax on interest can push the real after-tax return on idle francs below zero.
• Fiat money is backed by an institutional commitment — an independent central bank with a price-stability mandate and the ability to withdraw money as well as create it — not by a commodity; the franc's gold link ended in 2000 and the commitment took its place.

Sources

• Swiss National Bank, Our monetary policy in brief and the SNB's published definition of price stability as CPI inflation below 2% per year (snb.ch).
• Federal Act on the Swiss National Bank (National Bank Act, NBA) of 3 October 2003, and Article 99 of the Swiss Federal Constitution on monetary policy and the SNB's mandate.
• Carl Menger, "On the Origin of Money", Economic Journal, 1892 — the classic account of money emerging from the saleability of goods rather than from decree.
• Nobuhiro Kiyotaki and Randall Wright, "On Money as a Medium of Exchange", Journal of Political Economy, 1989 — the formal treatment of the double-coincidence-of-wants problem.
• R. A. Radford, "The Economic Organisation of a P.O.W. Camp", Economica, 1945 — a first-hand observation of a commodity money emerging, inflating and collapsing in a closed economy.
• Michael McLeay, Amar Radia and Ryland Thomas, "Money creation in the modern economy", Bank of England Quarterly Bulletin, 2014 Q1 — on why most money is commercial bank deposits.
• Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867–1960 (Princeton University Press, 1963) — on monetary aggregates, banking panics and the consequences of losing the medium-of-exchange function.
• Bank for International Settlements, Committee on Payments and Market Infrastructures, publications on payment finality and settlement in central bank money.