What is Money?

What is Money

Although economics isn’t about getting rich quick, it all boils down to trading things you have for the things you want. Imagine you live in a world without money, and you’re a dentist that wants to go buy a car. First, you need to find a bunch of auto workers who need dental work. If these workers don’t want dental services and prefer being paid in something else like flat-screen TV’s, then you have to find TV manufacturers that have toothaches. This is called the “barter system”, and it takes a lot of time and energy.

Of course, many people still barter for stuff, but for most transactions, we use money.  Which is a way more efficient way to do business. The people who really need dental care will pay you with money, which you can now use to buy a car. Economists point out that money serves three main purposes:

# The 3 Main Purposes of Money

First, it acts as a “medium of exchange”. It’s generally accepted for payment for goods and services.

Now, that medium of exchange means we’re not stuck in the barter system.

Next, money can be used as a “store of value”.

The reason why a dentist doesn’t normally accept fruit or baked goods is because you can’t save those things up to go buy things like cars.

Money also serves as a “unit of account”.

We don’t measure the value of cars in bananas, muffins, or root canals.

Instead, we use money because it’s a standardized metric that allows us to measure the relative value of things.

Most people assume that money is just cash and coins, issued and endorsed by a government. Coins have been used for thousands of years, and they’re a great example of money, but technically, money is anything that’s used as a medium of exchange.

For example, cigarettes were used as money in prisons until smoking bans were put in place. Nowadays, prisoners use postage stamps and even small packages of mackerel as currency.

Animals like cattle and sheep, also sacks of grain, all these have been used as money. Some societies even used feathers or shells. The point is what economists consider money is anything that’s accepted as a medium of exchange.

# Money Nowadays

But that’s changed a lot over time. Today, cash and coins are often used as money since they’re easy to carry around, physically durable, and hard to counterfeit. But a lot of money today doesn’t end up in anyone’s pocket or wallet. It moves around electronically.

Increasingly, people get paid in the form of checks or direct deposits into their bank.

A lot of our money isn’t physical. It’s digital. It exists on some bank’s computer. And as long as that computer is secure, and your nation’s monetary system is functioning as it should, those electronic dollars do all the things they’re supposed to do.

Another form of digital money that you often hear about is Bitcoin. Bitcoin is a virtual currency that is not issued or regulated by a specific country. But since some people accept it as payment, many economists consider it money.

Unlike other electronic currency, Bitcoin doesn’t involve a bank, so people can, in theory, buy things more anonymously. This appeals to people who don’t trust central banks, and also people who want to buy illegal stuff online. That illegal trade means law enforcement and regulators are also very interested in Bitcoin. Bitcoin isn’t only for internet drug deals though.

There’s a lot of speculation in Bitcoin, meaning people buy up Bitcoins, hoping to turn a profit on them. This makes Bitcoin more of a speculative asset, and limits its use in buying and selling actual goods and services.

Could Bitcoin or another virtual currency be how everyone pays for things in the future? Who knows!

# What Gives Money its Value?

There’s kind of a glaring question here: what makes these pieces of paper so valuable?

Well, in the past, each dollar issued by the U.S. government was redeemable for a specific amount of gold.

That was called the “gold standard”, and it meant that the government couldn’t issue more money than it had in gold reserves. Back in the 1930’s, the U.S. decided to move off the gold standard and some people freaked out about not having something tangible to back our money.

But it’s important to remember that money, whether it’s cash, or gold, or small pouches of mackerel, is all about confidence.

The Nobel Prize winning economist Milton Friedman said, “The pieces of green paper have value because everyone thinks they have value.” With that in mind, a gold standard, or even a mackerel standard, might not make money more valuable or reliable. A lot of economists agree with this, which is why no country uses the gold standard.

 

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