What is money?

Money is a tool that helps transactions, so people do not need to rely on barter. This type of commerce is much more efficient than barter, because in the case of barter, two people need to meet, who need each other merchandise, which is difficult. If we have money in that case any person with money if finds a good or service that he wants, the transaction takes place.

That is why even in times where there was no actual money, some kind of asset emerged, accepted by almost everybody, for example cigarettes, chocolate or watches during the world wars.

We have two fundamentally different monetary systems. The first is closer to barter. In this case the money is an already existent asset, the other type of money is the base is debt.

Another important function of money, it is that stores wealth, so one can produce wealth at a given time and spend it later. This is really important. Let’s say that somebody produces apples, he cannot eat all the apples when apples ripe, and not to eat the rest of the year. He cannot store the apples for a whole year to eat them later or barter with them through the year. However if he can sell it and store that welt in form of a durable asset or money, he could live of producing just apples.

I will start with the system that’s based on real existing assets. This means that a given asset already exists. This was the first kind of money. It evolved from barter.

In this case somebody who wants to buy anything, he needs to have some kind of asset.

In case of barter one person could exchange his fish for bread.

The first type of money was some kind of asset universally accepted, for example, cattle, shells, gold or silver.

Money needs to have a few properties:

  • portable
  • durable
  • divisible
  • fungible 
  • ideally it is also a store of value

Cattle is not fungible, because are not two identical animals, it is not divisible, not really durable, in a few hundred years it will worth less. Besides that is not really portable either.

Crude oil for example has almost all the properties needed to be money. Accepted all over the world, durable, divisible, fungible, the only property is lacks is portable.

Gold and silver and other precious metals hold all the necessary properties to become good commodity money, which is why they were used as money for most of history. 

Silver for example has been used as money for more than 2000 years, and ‘Silver’ still means money in more than 14 languages including Spanish, French, Brazil, Portuguese, and Welsh

If an entity like a bank or a country issues paper money backed by these assets for better portability, the assets still exists, so they can be redeemed at any time.

The USA dollar was redeemable in gold and silver.

The other type of money is debt.

In this case if somebody wants to buy a bread, but has nothing to give instead, he will give a promise, an IOU I ow you, and he can repay its debt later, or provide some other services, like work the debt of. Now the person who received this IOU could trade this IOU for other things, and the IOU than needs to be payed to the person who owns the IOU.

In case of this monetary system, if all debts are payed back, all IOU-s disappear from the system, so all money disappears.

The advantage of the first or asset based monetary system is that, the wealth already exists, and that backs the money. This means that this monetary system is much more stable. The drawback is that a transaction can appear, only if both parts in a transaction have sufficient assets. Because of this fewer transactions take place and the economy works slower.

In the case of debt based money, there is always a possibility that the person who owns the debt will not pay.

At a society level this could also mean, that the backer who sold 10 breads which was one day of work, when he spends his money he can buy only 9 breads or 2 or none.

The advantage of this monetary system is that a lot of transactions can take place that otherwise could not take place, the disadvantage is that increases the number of those transactions, that should never take place. This system is much more unstable and potentially it can even collapse.

Currently the world uses a debt based monetary system. This made possible a faster growth, however it is more unstable.

There is nothing to back up the value of money, just the faith of the people in it, and the fact that we need to pay are taxes in that currency. Because of this if people lose faith in the money or the government, the money can lose all its value really fast.

How does the tax system work? I will talk about this subject separately.