Is seems like such a simple question: what is money? But if you really consider it, it is a lot less straightforward than it seems at first. glance. Think about it: why would anyone give you nice stuff in exchange for a piece of paper, or even stranger: in exchange for just shifting some numbers (which is what happens when you use your credit card). The actual value of the paper is nothing, you can’t even use to take notes, because it is already stuff printed on it! You’d have to be crazy to trade things with real value, such as groceries or a book, for such a worthless peace of paper. And yet, we all do it all the time… The big question is why? To answer it, we need to really understand what money is.
The rise of money
To know what money is and to answer the question of “why”, we should go back in history, to see how and why money came into existence. Maybe if we know where money came from, we can understand why we value those pieces of paper so much. Below you will find a very short version of the tale of money, if you want to know more, you can find lots of information on Wikipedia.
Money arose because people needed some kind of trading mechanism when they were exchanging product or services with one another. Trading stuff directly (i.e. without the interference of money or money-like requisites) is called bartering and it is the oldest way of trade that people have used. Let’s imagine a bit how bartering worked. Suppose you have a cow and you need some bread. The first thing to do is determine how many breads one cow would be worth. Once you have established that (let’s say one cow equals 100 loafs of bread), the next problem would be that you can trade 1/100th part of a cow for one loaf, but you probably don’t want to buy 100 loafs of bread at once. To overcome things like this, people started to make agreements like: You give me one bread every day, and after three months you get my cow. But suppose the cow died during those three months? So the baker would want some kind guarantee in return for his bread, which he could exchange for a cow after three months. Basically, that guarantee is exactly what money is all about.
Shells, rocks and gold
At first, people used stuff like shells and special rocks as guarantees/money, because they were easy to keep and hard to copy. Later, those things were replaced by precious metals, such as gold and silver. These metals where divided into small amounts, which had an inscription with their value, which were the first coins. When people got richer, they did not want to keep all their coins in their houses. It was much safe to have someone guard your gold for you, someone you could trust and who had a sturdy building with good security. This is how the first banks emerged.
If you took your coins or gold to the bank, they would give you a written statement, which declared how much coins or gold you deposited. After a while, people found out that these statement themselves were just as good for trading as the actual coins were. Banks started to standardize these statement and those were the first banknotes. Fast forward a couple of years to the introduction of computers, and paying someone is just a matter of decreasing you account, while increasing that of the other person: digital money is what it’s all about these days.
The value of money?
If you look at the development of money through the years, you see that the value of money has shifted from “real” (intrinsic) value, towards value that is just there because we say so. This is, obviously, only possible if we have trust in the people or organizations who “say so”. As long as we all trust and believe in the value of our money and are willing to trade things for it, it will keep its value. This is called a self-fulfilling prophecy and you might consider it a bit weak to base a financial system on, but it has been working for quite some time!
Fortunately we do not have rely solely upon the fact that other people are willing to trade stuff for money. Even though the value of modern money isn’t in the material, it does exist in the organization backing up the money: they guarantee that you can exchange it for a certain value. Part of this role is played by banks, but the major player is the government, by means of the Federal Reserve Bank. This is an institute which was brought into life, just to ensure that the value of our money is stable. They have all sorts of mechanisms to control the actual value of our dollars, and use these extensively to provide both national and international monetary stability.
Hopefully this article has explained the mysteries of money a little bit. Next time you ask yourself “what is money and why do we trust it so much”, you will hopefully have a better understanding of the underlying mechanisms and history. Please let me know what you think about money…