This is a good question. It’s important to get a handle on this topic, as it will help you keep hold of more of your money in the future.
However, even when people do ask this question, most of them do not listen to the answer. And so, they stay at risk of losing their money.
In this article, we’ll look at:
- How money is created.
- Why money is dangerous.
- How you can protect yourself from the danger.
So, What is Money?
Despite what they say, in reality, most people don’t really know.
Even some really bright people have trouble with the concept. They may keep a keen eye on business and watch the financial news everyday, but they rarely look into this fundamental question.
They have a idea or two about notes, coins and banks… but if you really press them on the question, they will not be able to give you a good answer.
This article will give an explanation of money for the person in the street. For the normal people who go to work everyday and earn money. It will explain the stuff that we:
- Get paid with,
- Buy our food with, and
- Try to save.
If you are at all concerned about keeping hold of what you earn, then you need to take in the following information.
Note: This is not an academic paper. It is not an in depth technical examination of how money functions in an economy. Nor is it a philosophical piece about what money should be. If anything, it’s a warning.
To begin with there are actually two things about money that we need to understand:
- Money is trust.
- Money is debt.
Let’s look at number one first.
1. Money is Trust
Money is used as a means of exchange. It has very little value in and of itself. The money that we use now in our societies has developed over time to allow us to trade for the things we need to live more easily.
As an example, I fix cars for a living and you paint houses.
You need your car fixed… but at this time I don’t need my house painted.
What can we do?
We cannot exchange our skills at this point, so to save you the hassle of having to find a mechanic who needs their house painting, you can give me money and I’ll do the job. I can then keep the money and exchange it for other products and services that I need.
Simple and efficient. It’s a good system.
But, when you give me cash in the form of notes and coins for your car service, you go away happy as you have got what you need… but what about me?
What am I actually holding? Bits of paper and metal. Not actually worth much at all. I can’t eat them, wear them or live in them.
This is where the key element into play – Trust. This is what gives money its value.
I have to trust that someone else will accept these bits of paper (in reality, they could be bits of glass, pieces of cloth, pieces of wood etc.) for goods and services. If they don’t, then I have just wasted a whole lot of time and effort fixing your car.
And the person I give the money to has to trust it and so on down the line, as the money exchanges hands for all kinds of things.
That’s a lot of trust.
We are Forced to Trust
But what are we trusting here?
Ultimately, we are trusting the
- Financial system.
But there has to be some value to it, right? Why the hell are we trusting millions of strangers to do right by us and exchange our money for what we need?
We need to pick up on a crucial point here. Aside from the fact that money has no intrinsic value, another punch in the stomach is that it’s not yours.
That’s right, the stuff in your bank account is not yours, it belongs to the bank. You lent it to them when you deposited it… and they can do what they want with it. They are under no obligation to give it back to you.
And it gets worse…
Money for Nothing
Not only do the banks not have to give it back to you, they created it out of thin air in the first place.
Yes, it’s true!
In the modern economy, banks create money when they make a loan.
It is a common misconception that banks just take deposits from customers and lend them to other people. If you get a mortgage from a bank to buy a house then the bank simply puts the money in your account by tapping a few keys on a computer.
They have the power to create money for nothing. And don’t forget that banks are private companies. They are not owned by the public, yet they have the power to control our money supply.
When banks create money and give it to a borrower, that person goes into debt and is expected to pay back more than they originally borrowed. That person is promising a piece of their future productivity to the bank in exchange for numbers on a computer screen.
And this is the money that we all use in our everyday lives.
Therefore the second answer to the question “What is money?” is…
“Money is debt”.
(As I said before this is not an in depth technical examination of money creation. See this from the Bank of England for a detailed explanation.)
2. Money is Debt
Most of what we use everyday is not actually real money ie. the notes and coins issued by a central bank.
The stuff we use everyday on our debit cards and in electronic payments is bank credit. It’s the stuff that the bank created when it made the mortgage loan to Mr. and Mrs. Smith that has been spent into the economy. It has to stay in the banking system for it to act in the same way as money.
The notes and coins, some of which you may have in your pocket right now, make up a tiny percentage of the money in circulation (Only 3% in the UK!)
Most of it is numbers on screens.
Now we are really pushing the trust!
For the most part this works well enough, if everyone remains calm and trading conditions are normal. If they have a job, then any individual can (usually) get hold of enough money to live day to day.
And if you as an individual wanted to, you could fairly easily arrange to get all of your money out of your accounts and into cash notes.
(Doing that would obviously create other problems for you and is part of the reason there are banks in the first place… but that is another issue.)
The Danger of Money
But imagine that at the same time, everyone wanted their money meaning the banks had to provide cash to satisfy all their customers needs simultaneously… perhaps during some kind of crisis… when the essential trust might start to wear a bit thin…
Well, it couldn’t be done.
There just isn’t enough cash notes and coins in the system to do it. Not by a very long way.
(Think about how often you use actual cash these days. Certainly people don’t use cash to make massive purchases such as houses. That stuff just goes from computer to computer).
If everyone wanted to get into cash, that’s when you would start to see things get a little scary.
Now before you panic and head to the bank, large scale collapse of the monetary system is unlikely… but anything approaching it would get very frightening.
If recent responses by central banks are anything to go by we would likely see new money printing on a massive scale. The danger of this is inflation and this is another enemy to holding money… aside from the fact it is not worth anything and it is not actually yours!
How to Be Money Smart
So, if you are interested in creating wealth (or even just being financially secure) you shouldn’t think in terms of just getting more money. You need to exchange the money (some if it, we all need emergency cash) for assets.
These are things of real value that can be used for a practical purpose themselves, unlike paper money.
Think of what we humans actually need to survive:
So, it’s not surprising a simple idea of assets would be stores or grain, bails of cotton, and land and buildings. These are things people actually need everyday just to get by.
But of course it is impractical for most of us to buy and hold those things, and so a sophisticated market for buying and selling assets has developed over the centuries. It allows us to hold assets and benefit from their value without actually physically touching them.
Investing money into stocks, bonds, REITs etc., which can all be purchased relatively easily, means we can hold assets.
Now, there are all kinds of risks to holding these things as well, but with adequate research we can reduce those risks to levels we are happy with.
Note: It’s understandable that many people shy away from buying stocks and other securities. They have seen market crashes on the news or have heard horror stories from friends or relatives about someone losing their life savings. But once you have a look at what’s under the hood then it is not too difficult to understand.
Think About “Value”
Thus, chasing more money to increase your bank balance is not the way to think about it. It may look nice and provide you with some comfort, but we need to be objective here.
For a start, as we have seen above, keeping huge amounts of money in banks is not a good idea. It’s not yours and you could lose a lot of it in a crisis. Either to outright confiscation or inflation.
You need to think about the amount of goods and services that the money you are making can be exchanged for. This is money’s “value”. And it is constantly changing.
(Mostly in a negative way. How much bread could a dollar or pound sterling buy 100, 50 even 10 years ago?)
One hundred dollars will not always buy you the same amount of goods. So you need to work on ways to protect that “value”… because believe me, the banks and the government will NOT protect it for you.
1. Money is trust and,
2. Money is debt.
Unfortunately, we have no choice but to trust the money system.
But in a wider sense, be careful who you trust. In financial matters a healthy dose of skepticism will help you make much more profitable decisions in the long-term.
And think before you go into debt. We are forced to use debt-based money, but we can still choose when and how much personal debt to take on.
What do you think about money? Do you worry about the money in your bank account? Do you trust banks and the money they supply you with? Please leave your comments below.