What is money or Why do we need Money?
I can imagine you chuckle at this question, but I ask you why do we need the “concept” of money? Let’s understand this first at a beginner’s level. I hope to progressively expand this for a more deeper understanding later, but for now, the basics.
Money is a financial tool, an invention nearly as old as agriculture and wheel.
But present day ‘Money’ is also a story. Before we get to it, let’s see what happens if the concept of money did not exist.
We all have needs & wants, but we cannot produce all that we need and create all that we want. Some examples of the limitations are:
– My location doesn’t help (I cannot grow apples in my geography or have petroleum beneath my ground).
– I don’t have the know-how to produce it (from growing vegetables to making automobiles or aircraft).
– I may not have the authority to do it (build a copper smelting plant or start an iron foundry in my garden).
– Social contracts may prohibit (I cannot bury my dead in my apartment compound).
Since we cannot produce everything we need, there is a necessity to trade, exchange goods & services — even for personal needs (food, transportation, haircut, tuitions etc.)
Barter was an option that was very popular at one time (and even used very occasionally in this day and age) but it is not convenient. For those who aren’t familiar with barter, this is how it goes.
– I have something that I am ready to give away in exchange.
– Another person has something I want.
– The other person should have a need (or a want) for the goods I have — at the same time I need what the other person has. (‘coincidence of wants’).
– We both are accessible to each other (or we would need some intermediation service like that of a broker)
– We both are acceptable to exchange with each other.
– We need to establish the value of each others’ goods (how much gold for a haircut or a glass of milk) in each trade. This also means we need to publish the price list of all commodities in every other commodity / service. This discovering the price of each item against another can be daunting, and even unfair at times.
– Minimum transaction quantity became a problem (cannot give half a haircut for a litre of milk)
– Physical exchange has to happen.
Since there were so many limitations, we needed to have an intermediary medium of exchange that had certain characteristics.
- It should have value — not necessarily in itself but should be able to buy value at will.
- Should be convenient to use, store, retrieve, transfer the title. I own 100 US dollars and if I give it to you in cash or deposit in your account, it becomes yours.
- Fungible (a 1 dollar coin and a 1 dollar note have the same value — even though the material (intrinsic) value for both are different). Similarly 100 cents and 1 dollar are the same value, irrespective of the shape and form.
- It should be durable. Not only should it be available across time but also weather any wear & tear. Let me explain. I stash cash under my mattress, forget about it and be able to use it after a year. Also my one dollar note is torn? I should be able to exchange it for a new one dollar note.
- Establish “Price” for every good or service with a single rate card. For example, 10 dollars for a haircut, 5 dollars for a litre of milk or a Kg of Rice. As opposed to 2 litres of milk or 2 Kgs of rice for a haircut or half a haircut for a litre of milk.
- But the most important characteristic of all is the acceptance. Others in your community should “accept” that it is currency. Pokemon cards and Monopoly money too are currencies — but with limited acceptance within a closed group. But a true currency should be acceptable across a wider community of people — usually across a country or a wider region.
So came the tool called money as a medium of exchange.
What forms of money have we seen?
- Cattle
- Precious or semi-precious stones
- Precious or semi-precious metals. Gold, Silver, Iron, Tin, Copper, Aluminum, Nickel (rings a bell isnt it)
- Salt….(the etymological root to the word Salary)
Each of the above served as money for a while in its time. And they also had their limitations, so a new virtual value was created — Printed or Minted money — with a guarantee by the issuing authority — a king or a central bank in today’s world. Of course, for keeping the trust on the guarantor, the country has to have a robust economy, a mighty power – both military power & soft power – to make sure that guarantee is believable.
Today, central banks issue a guarantee on a piece of paper or cloth (that costs say 50 cents) and call it — say 10 dollars. Although the physical piece of paper costs only a few cents to make, we are ready to believe (in the story) that it is indeed 10 dollars because of the guarantee. That is how a guarantee became currency.
Money underwent a A BIG TRANSFORMATION. We settled for and accepted an apparently value-less (or less value than indicated) commodity due to the trust we have in the guarantee & the guarantor.
The biggest factor for a currency’s success is when both the buyer and seller TRUST that a fair value exchange has happened, even when one of the commodities is just a piece of paper.
Over the last couple of decades, with modern technology in banking, we don’t even exchange paper anymore but are satisfied with a virtual electronic unit.
The most popular form of ‘present day’ money is a magnetic medium, that holds an electric charge in the form of binary value, stored in some remote location inaccessible to the general public. We don’t hold it in our hands, we don’t even see it, but are happy with a bank statement, an email or even an SMS, that says we have money in our account. That is the story called money that most of us believe in.
Picture Credits
Collage made from pictures, thanks to: Steve Ruby & Shubham Dhage on Unsplash and gorartser & LeonMay on Pixabay
Click on the urls below the images below to view the previous and next articles in this series
