We used the word "money" as if it were obvious. It is not, and getting it precise is the difference between understanding the machine and being mystified by it. Economists define money not by what it is made of but by what it does. It has three functions:
- Medium of exchange. It is accepted in trade, which solves the crippling problem of barter: the double coincidence of wants. In a barter economy, for me to get your rice I must happen to have something you want right now. Money breaks the deadlock: everyone accepts it, so I sell my labour for money and buy your rice with it, and we never have to want each other's specific goods at the same moment. This is money's first and most important job.
- Unit of account. It is the common ruler in which prices, debts, and profits are quoted. When a company reports revenue "in ₹ crore," the rupee is doing its unit-of-account job. It lets you add a bank's income to a software firm's on one scale. (You have relied on this in every statement you have ever spread.)
- Store of value. It holds purchasing power across time, so you can earn today and spend next year. This is money's weakest function and the one inflation attacks: money that loses value fast (Argentina, Weimar) stops being a store of value first, then a unit of account, and finally, in a hyperinflation, even a medium of exchange, as people flee to dollars or goods.
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What types of money are there?
What has served as money. Historically: commodity money (things with intrinsic use, such as cattle, salt, and above all gold and silver, which are durable, divisible, portable, and scarce); then representative money (paper claims redeemable for a fixed weight of gold, the classical gold standard); and today, everywhere, fiat money, meaning rupees and dollars that are money by government decree and, crucially, by collective acceptance. A ₹500 note is a worthless piece of cotton-paper intrinsically; it is valuable because everyone will accept it, the government demands taxes in it (so you must acquire it), and it is legal tender for debts.
Fiat money is a shared social convention backed by an institution. That is not a weakness to sneer at, because it is what lets a central bank manage the money supply, but it is why trust in the institution is the ultimate backing of a modern currency, and why the reserve-currency Big Cycle in Dalio's economic machine is a cycle in trust.
Is most money cash or bank deposits?
The fact that reorganizes everything: most money is not cash. When you picture "money," you picture notes and coins. But add up a modern economy's money and the notes-and-coins are a small slice. The rest, the great majority, is bank deposits: the balances in your savings and current accounts, numbers in a bank's ledger. Those numbers are money in every functional sense: you pay with them (UPI, cards, cheques, wire), prices are quoted in them, you store value in them. This is not a technicality; it is the hinge of how banks create money. Because if most money is bank deposits, then whoever creates bank deposits creates most of the money. And that is not the central bank. It is the commercial banks, and they create deposits by lending. Sit with that until it feels strange, because the textbook story you are about to learn first will try to talk you out of it, and the modern correction will put it back.
What are M0, M1, M2 and M3?
Central banks classify money in nested aggregates you should recognize: M0 (the "monetary base" or "reserve money": currency in circulation plus banks' reserves at the central bank; this is the money the central bank directly creates); M1 (M0's currency plus demand deposits, the most liquid broad money); and M2/M3 (adding savings and time deposits, "broad money," the stuff the whole banking system creates). In India the RBI publishes M0–M3; in the US the Fed publishes M1 and M2. The gap between the tiny M0 and the large M3 is precisely the money that commercial-bank credit created. (Rough orders of magnitude, India, as of mid-2026, check against RBI: broad money M3 runs several times the monetary base M0; the exact multiple moves and you will pull it live in M7.07.)
How is money different from credit?
How credit differs from money. This is the distinction beginners collapse. Money settles a transaction and extinguishes the obligation: when you pay cash, nothing is owed, the deal is done. Credit does the opposite: it creates two things at once, a claim (the lender's asset) and an obligation (the borrower's debt), and settles nothing until the debt is repaid. Money is a stock of purchasing power you have; credit is purchasing power you borrow against your future. The barista paid in cash owns that cash outright; the household that "paid" with a car loan owns a car and owes a debt. Both transactions counted equally in total spending (that was Fact 1), but they leave the two economies in utterly different states. The cash economy owes nothing and can repeat next year. The credit economy has pulled a future rupee into the present and must, someday, send a present rupee into the future to make it whole.
That asymmetry is the engine of every cycle in Dalio's economic machine.