What Is Money? Overview

Money makes the world turn. Economies depend on the exchange of money for products and services. Economists define money, where it comes from and how much it is worth. Here are the many characteristics of money.
Exchange medium
Before the development of a medium of exchange, that is, money, people exchanged the goods and services they needed. Two individuals, each in possession of certain assets that the other wanted, would sign an exchange agreement.

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The early forms of barter, however, do not provide the transferability and divisibility that make trade efficient. For example, if someone has cows but needs bananas, he must find someone who not only has bananas, but also has a craving for meat. What if that individual finds someone who needs meat but not bananas and can only offer potatoes? To get the meat, that person has to find someone who has bananas and wants potatoes, and so on.

The lack of transferability of commodity barter is exhausting, confusing, and ineffective. But that’s not where the problems end; Even if the person finds someone to trade meat for bananas with, he may not consider a bunch of bananas to be a whole cow. Such a trade requires reaching an agreement and devising a way to determine how many bananas certain parts of the cow are worth.

The money produced solved these problems. Commodity money is a type of commodity that works like currency. In the 17th and early 18th centuries, for example, American settlers used beaver skins and dried corn in transactions.1 With generally accepted values, these products were used to buy and sell other things. Goods used for trade had certain characteristics: they were widely desired and therefore valuable, but they were also durable, portable, and easy to store.

Another more advanced example of commodity money is a precious metal like gold. For centuries, gold was used to back paper money, until the 1970s.2 In the case of the US dollar, for example, this meant that foreign governments could take their dollars and exchange them at a specified rate with gold with the Federal Reserve. from the United States. What’s interesting is that, unlike beaver skins and dried corn (which can be used for clothing and food respectively), gold is only valuable because people want it. It’s not necessarily helpful – you can’t eat gold and it won’t keep you warm at night, but most people think it’s cool and they know that others think it’s cool. So gold is worth something. Gold, therefore, serves as a physical sign of wealth based on people’s perceptions.

This relationship between money and gold provides information on how money gains its value, as a representation of something valuable.

Impressions create everything
The second type of money is fiat money, which does not require the backing of a physical commodity. Instead, the value of fiat currencies is determined by supply and demand and people’s belief in their value. Fiat money developed because gold was a scarce resource and fast-growing economies could not always extract enough to meet their currency supply needs.3 4 For a booming economy, the need for gold to value money is extremely inefficient, especially when its value is actually created by people’s perceptions.

Fiat money becomes the sign of people’s perception of value, the basis for creating money. A growing economy is apparently managing to produce other things that are valuable to it and to other economies. The stronger the economy, the stronger your money will be perceived (and sought) and vice versa. However, people’s perceptions must be supported by an economy capable of producing the products and services that people want.

For example, in 1971, the US dollar was removed from the gold standard: the dollar could no longer be exchanged for gold, and the price of gold was no longer set at any dollar amount.5 This meant that it was now possible to create more paper money . what gold to support it; the health of the US economy supported the value of the dollar. If the economy collapses, the value of the US dollar will decline both domestically due to inflation and internationally through exchange rates. The implosion of the American economy would plunge the world into a dark financial age, so many other countries and entities are working tirelessly to ensure that never happens.

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