Everyone uses money. We all want it, work for it and think about it. If you don't know what money is, you are not like most humans. However, the task of defining what money is, where it comes from and what it's worth belongs to those who dedicate themselves to the discipline of economics. While the creation and growth of money seems somewhat intangible, money is the way we get the things we need and want. Here we look at the multifaceted characteristics of money. (Get A Short-Term Advantage In The Money Market. This investment vehicle is often the perfect stop-gap measure for growing your money.)What is Money?
Before the development of a medium of exchange, people would barter to obtain the goods and services they needed. This is basically how it worked: two individuals each possessing a commodity the other wanted or needed would enter into an agreement to trade their goods.
This early form of barter, however, does not provide the transferability and divisibility that makes trading efficient. For instance, if you have cows but need bananas, you must find someone who not only has bananas but also the desire for meat. What if you find someone who has the need for meat but no bananas and can only offer you bunnies? To get your meat, he or she must find someone who has bananas and wants bunnies ...
The lack of transferability of bartering for goods, as you can see, is tiring, confusing and inefficient. But that is not where the problems end: even if you find someone with whom to trade meat for bananas, you may not think a bunch of them is worth a whole cow. You would then have to devise a way to divide your cow (a messy business) and determine how many bananas you are willing to take for certain parts of your cow. (It can be hard to talk about money with your children, especially when times are tough. Talking About Money When Times Are Tough has some tips to make it easy.)
To solve these problems came commodity money, which is a kind of currency based on the value of an underlying commodity. Colonialists, for example, used beaver pelts and dried corn as currency for transactions. These kinds of commodities were chosen for a number of reasons. They were widely desired and therefore valuable, but they were also durable, portable and easily stored.
Another example of commodity money is the U.S. currency before 1971, which was backed by gold. Foreign governments were able to take their U.S. currency and exchange it for gold with the U.S. Federal Reserve. If we think about this relationship between money and gold, we can gain some insight into how money gains its value: like the beaver pelts and dried corn, gold is valuable purely because people want it.
It is not necessarily useful - after all, you can't eat it, and it won't keep you warm at night, but the majority of people think it is beautiful, and they know others think it is beautiful. Gold is something you can safely believe is valuable. Before 1971, gold therefore served as a physical token of what is valuable based on people's perception. (You don't need an MBA to learn how to save money and invest in your future. Follow 8 Financial Tips For Young Adults, to find out more.)Impressions Create Everything
The second type of money is fiat money, which does away with the need to represent a physical commodity and takes on its worth the same way gold did: by means of people's perception and faith. Fiat money was introduced because gold is a scarce resource and economies growing quickly couldn't always mine enough gold to back their money requirement. For a booming economy, the need for gold to give money value is extremely inefficient, especially when, as we already established, value is really created through people's perception.
Fiat money, then becomes the token of people's apprehension of worth - the basis for why money is created. An economy that is growing is apparently doing a good job of producing other things that are valuable to itself and to other economies. Generally, the stronger the economy, the stronger its money will be perceived (and sought after) and vice versa. But, remember, this perception, although abstract, must somehow be backed by how well the economy can produce concrete things and services that people want.
That is why simply printing new money will not create wealth for a country. Money is created by a kind of a perpetual interaction between concrete things, our intangible desire for them, and our abstract faith in what has value: money is valuable because we want it, but we want it only because it can get us a desired product or service.How is it Measured?
Sure, money is the $10 bill you lent to your friend the other day and don't expect back anytime soon. But exactly how much money is out there and what forms does it take? Economists and investors ask this question everyday to see whether there is inflation or deflation. To make money more discernible for measurement purposes, they have separated it into three categories:
By adding these three categories together, we arrive at a country's money supply, or total amount of money within an economy.How Money is Created