What Is Money And How Does It Work?

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“If money is your hope for independence you will never have it. The only real security that a man will have in this world is a reserve of knowledge, experience, and ability.” — Henry Ford

efore the industrial revolution and information age, we had the agricultural revolution. When you think about it, hunter-gatherers had no money. How did they buy anything? Each tribe hunted, gathered and manufactured almost everything they required, from meat to medicine, clothing and sandals. They shared their goods and services through an economy of favors and obligations. Thus a simple barter emerged: ‘We’ll give you seashells, and you’ll give us high-quality flint, shoes, or whatever.’ The bartering economy was born.

The rise of cities and kingdoms, and with the improvement in transport infrastructure, brought about new opportunities for individual specialization. Populated cities provided full-time employment not only for professional shoemakers and doctors, but also for carpenters, soldiers, priests, lawyers and craftsmen. It was great these men and women could sharpen their crafts in order to barter for other goods and services. Furthermore, full-time specialist potters and artists, not to mention doctors and lawyers, could hone their expertise to the benefit of all. But specialization created a problem — how do you manage the exchange of goods between the specialists?

An economy of favors and obligations doesn’t work when large numbers of strangers try to cooperate. It’s one thing to provide free assistance to a brother, cousin or a neighbor, but a very different one to take care of foreigners who might never return the favor. One fall back on barter. Bartering is only effective when exchanging a limited range of products or services. It cannot form the basis for a complex economy.

For example, some societies attempted to solve the problem by establishing a central barter system that collected products from specialist growers and manufacturers and distributed them to those who most needed them. The largest and most famous experiment was conducted in Russia, and it failed terribly. Imagine everyone working according to their abilities, and receiving according to their needs. In theory it sounds great, right? Turns out that in practice everyone would work as little as they can get away with, and receive as much as they could grab. Sounds like the doing of the modern day government but I digress.

At any rate, more moderate and more successful experiments were made on other occasions too, for example in the Inca Empire. However, most societies found a simpler way to connect large numbers of experts and specialists — they developed money.

Money is not coins and banknotes. Money is anything that people are willing and able to use in order to represent systematically the value of other things for the purpose of exchanging products, goods and services. There have been multiple types of money in the world for hundreds and thousands of years now. Money has existed long before the invention of coinage, and cultures have prospered using other things as currency, such as shells, cattle, grain, cigarettes and promissory notes. For example, cowry shells were used as money for about 4,000 years all over Africa, South Asia and East Asia.

In modern prisons, even POW camps in World War II, cigarettes often served as money. I distinctly remember learning about this is one of my college macroeconomic classes. One Auschwitz survivor and POW described the cigarette currency used in the camp: ‘We had our own currency, whose value no one questioned: the cigarette. The price of every article was stated in cigarettes. In “normal” times, that is, a loaf of bread cost 12 cigarettes; a 10-ounce package of margarine, 30; a watch, 80–200; and a 0.25-gallon bottle of alcohol, 400 cigarettes!’ Can you imagine!

In fact, even today coins and banknotes are a rare form of exchange. The sum total of money in the world is about $60 trillion, yet the sum total of coins and banknotes is less than $6 trillion according to Niall Ferguson and The Ascent of Money: A Financial History of The World. Riddle me that? More than 90% of all money — more than $50 trillion appearing in our accounts — exists only on computer servers. For complex commercial systems to function, some kind of money, Bitcoin or electronic currency is indispensable.

Everyone always wants money because everyone else also always wants money, which means we can exchange money for whatever we want or need. Thus, money is a universal medium of exchange that enables people to convert almost everything into almost anything else. Sounds like magic to me! Since money can convert, store and transport wealth easily and cheaply, it made a vital contribution to the appearance of complex commercial networks and dynamic/booming markets.

How Does It Work?

Bitcoin, dollars, gold, silver and coins only have value in our common imaginations. Their worth is not inherent in the virtual or blockchain structure of the coin, or their color, or their shape. To phrase this another way, money isn’t a material reality — it is a psychological construct. It works by converting matter into mind. Why are we willing to flip hamburgers, cook french-fries, sell life insurance and investment products, put ourselves through residency and medical school, clean offices and service stations or babysit two obnoxious children when all we get for our services is a few pieces of colored paper, a bi-weekly direct deposit or a Venmo notification on our cell phones?

According to basic wealth principles, business, economics, and law, money is a system of mutual trust, and not just any system of mutual trust: money is the most universal and most efficient system of mutual trust ever devised in the existence and history of our world. What created this trust was a very complex and long-term network of political, social and economic relations. I’ll spare that history lesson for another day!

The basic scent, love, and crucial role of money for some individuals explains why our financial systems are so tightly bound up with our political, social and ideological systems. This is why financial corrections, crises and collapses are often triggered by political developments, and why the stock market can increase or decrease simply on the way traders feel on any given morning.

Furthermore, money was always linked to commodities, such as gold or silver reserves for the longest time. But after Richard Nixon and the United States abolished the system (gold standard) in 1971, the dollar become what is known as fiat money. Meaning not linked to any external resource but relying instead solely on government policy to decide how much currency to print. Many promises were made with that, which were promptly broken. It’s competitive for the U.S. dollar to compete with other global currencies when it is only worth about 19 cents today of what it was worth back in 1971.

Moving right along, by the late modern era the entire world was a single monetary zone, relying heavily first on gold and silver, and later on a few trusted currencies such as the British pound and the American dollar. Yes there is a lot of other history involved such as Rome’s empires, India’s markets, Muslim and European merchants, and Chinese silk and porcelain manufactures, but that is too much history to fit into one single story. That will be reserved for a much longer book of some sort.

It’s mind-boggling to think that people continued to speak mutually incomprehensible languages, obeyed different rulers and worshiped distinct gods and goddesses, but all believed in gold and silver and in gold and silver coins. Without this shared belief, global trading networks would have been virtually impossible to have imagined. Christians and Muslims, who could not agree on religious beliefs, could nevertheless agree on a pure monetary belief, because whereas religion asks us to believe in something, money asks us to believe in the fact that other people believe in something, i.e. a perceived value.

For many years, philosophers, thinkers and prophets have deemed money and called it the root of all evil. Personally, and I’ve said it before, money is not the root of all evil but a pure love of money and not doing any good with it can be seen as evil, or negative. When we boil money down to the grassroots level, money is more open-minded than language, state laws, cultural codes, ethics, religious beliefs that can bridge virtually any cultural gap, and that does not discriminate on the basis of say religion, gender, race, age or sexual orientation. Thanks to money and our global economy today, people who don’t even know each other and don’t at first trust each other can nevertheless cooperate effectively and efficiently.

Money is based on two simple and universal principles: 1) universal convertibility and 2) universal trust. Convertibility in the sense of thinking as an alchemist. We can turn land into loyalty or wealth, justice into health, spent money into earned money, and violence into knowledge. Trust where as money is seen as a go-between, where any two people can cooperate on any project, task or creation of a product. These two principles have enabled millions and billions of strangers to cooperate effectively in trade, networks and industries.

It is common today when everything is convertible, and when trust depends on anonymous Bitcoins, dollars, cigarettes and services, that it damages or destroys local traditions, historic landmarks, intimate relationships and human values, replacing them with the cold hard truth and laws of basic supply and demand. Humans and families have always been born, raised and grown up on belief and values in “priceless” things, such being honor, loyalty, morality, love and respect. These values lie outside of the domain of the market, and could never be bought or sold for money.

When we think about it, the economic and monetary history of humankind has been somewhat of a delicate dance. People rely on money to facilitate cooperation with strangers, but we’re afraid it will corrupt human values and intimate relationships. Yes this is true seeing as 50% of marriages fail because of finances and a lack of money.

It is common today to believe that the market always prevails and wins. In a way it does but this is also a naïve way of thinking. Barbarians, savages, warriors and religious fanatics have repeatedly managed to overwhelm calculating merchants and concerned citizens, and even reshaped the economy as we see it today. It is therefore almost impossible to understand the unification of humankind as a purely economic process. I certainly see it as much more than that. And I realize I am not the only one in that state of mind.

In closing, nothing in life has meaning except for the meaning that we give it. Don’t we do this same thing for money? We either assign it a positive or negative feeling. After reading this, I hope your viewpoint, philosophy and stance on money has been further educated, if not changed. My goal was to let you dive further into what I deemed money to be and some of the parts of its inner-workings.

Thanks for reading and have a great day!

My Very Best,

Donovan Vogel

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Philadelphia based teaching financial literacy | Prospering all other hours | Writer | Lifter | Reader | Traveler | Freedom & Wellness

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