WHAT MONEY MEAN TO US??

Money is primarily a medium of exchange or means of exchange. It is a way for a person to trade what he has for what he wants. Ideal money has three critical characteristics: it acts as a medium of exchange; it is an economic good; and it is a means of economic calculation.

To properly understand money as a medium of exchange one must first go back to the first methods of trade. Before money was invented one would have to engage in direct barter. A farmer who produced grain – but wanted shoes for his family – would have to find someone who, a) had shoes and, b) wanted grain. You can imagine the difficulty involved in finding that perfect someone who had what the farmer wanted and wanted what the farmer had.
Out of necessity, this gave rise to indirect barter. Continuing with our example above, let’s assume that the farmer found a shoemaker but discovered that the shoemaker did not want grain – he wanted candlesticks. While having a drink at the local pub he overheard the gentleman next to him lamenting that he needed grain in exchange for his candlesticks. Naturally, the farmer traded his grain for the candlesticks and went back to the shoemaker and traded the candlesticks for shoes. In this example, the farmer performed indirect barter when he used the candlesticks as a medium of exchange.

Over time, different commodities served as medium of exchange but the problem of marketability and durability came into play. A necessary and highly exchangeable commodity was food. The problem is that it was perishable. One had to either use it or trade it before it went bad. Over time, the most marketable and durable commodities came to be used as medium of exchange – commodities such as gold and silver. Since gold and silver  did not rust nor rot they were ideal economic goods. Over time they became the preferred medium of exchange.
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

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.