Tuesday, June 28, 2011

What is Money Anyway?

When you think about money, the first thing that comes to mind is wanting to have more of it.  Have you ever wondered what it really is?  Sure, it pieces of pretty paper in your wallet, metal coins under the cushions of your sofa, and what the government likes to take away from you.

Did you know that money is actually a commodity?  Huh?  In case you need a refresher, here is a short post explaining what a commodity is:  http://economicefficiency.blogspot.com/2009/01/what-is-commodity.html.

Money is indeed a commodity, but first, it is a commonly agreed upon representation of a unit of work.  Chew on that one for a minute.  Because Amazon doesn't accept chickens for Kindles, and the bank doesn't accept lawn mowing for your mortgage.  People agree to accept money in the form of their local currency in place of chickens, or whatever work you perform.

Historically, money has taken the form of gold, silver, sea shells, and any other item people agree has value.  Paper money has been around much longer than people think.  Letters of Credit, which allowed a traveller access to money in another town or country have been in use since the before the Middle Ages.  The Knights Templar were known as the world's first foreign currency exchange, using Letters of Credits and other instruments to exchange money.

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Even the Bible (John 2:13) records Jesus running out the money changers in the Temple.  2000 years ago, Jews would bring local currency to the Temple to buy doves or other offerings.  However, they were only allowed to buy those things with Temple currency, and thus the exchange.  Jesus was angry that people were using a holy place, a place of worship, to make a buck off the average Joseph.

Fast forward to today with discussions of "the Fed printing money" (which is inaccurate) and rapid devaluation of the dollar as well as the Euro.  What does this all mean?  In short, governments can determine, through multiple means, the value of their national currency.  The value can be manipulated (lowered, ahem, China) to encourage cheap exports, or supported (Japan) to help stave off recession.

Ultimately, it is a matter of perspective.  A strong currency means imports are cheap, foreign travel is affordable, everybody likes to feel strong.  However, it also means that exports are more expensive (less competitive), tourism is down, and it is only a matter of time until the market swings the other way.

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Weaker currencies also spell inflation.  As the value of the US dollar has decreased, the cost of crude and other imported commodities has sky rocketed.  Why?  Many international commodities such as crude and airplanes are sold in US dollars.  When the dollar is weak compared to other currencies, it takes more dollars to buy the same things.

Money is a medium of exchange, the representation of a unit of work.  It only has value because society at large agrees to it.  For centuries, it was gold, jewels, and other finite things.  In modern times, paper money, also known as fiat money, is not backed by material things, but rather by the productive capacity of the nation that issues it.

So, the next time you put your money on the counter for what ever it is your are buying, think about how much time you had to work to purchase that item.  When you do, budgeting becomes much easier and you really start appreciating what it takes to make and spend money.
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