What IS Money?

photo credit: srish

Beyond saying that money is a medium of exchange, what exactly is money?

There are four types of money:

1. Commodity money.
Throughout history, people have used different commodities as a form of money: gold, silver, salt, beads, peppercorns, shells, corn, labor, cigarettes, rice, corn, or any “thing” can be used as a form of money. All that’s required for something to become money is someone willing to accept it as such.

2. Representative money.
This type of money is coins, paper certificates, or even digital certificates that be easily or reliably exchanged for a fixed amount of a certain commodity. Certain currencies are still backed by commodities, including the Euro, which is backed 20 percent by gold.

3. Fiat money.
Fiat money is determined solely by legal means. Fiat money has no intrinsic value and has no guarantee that it can be converted into gold or into another commodity, but it derives its only value from a government order (fiat) that it must be accepted as a means of payment. The US dollar is a fiat currency, backed only by faith in the US government.

4. Credit money.
Credit money is a claim against a person or other legal entity that can be used for the purchase of goods and services. Credit money is different from commodity and fiat money since it isn’t payable on demand and there is an element of risk that the real value of the claim will not be equal to real value expected at the time of purchase because of inflation.

Since the US and in most countries are dealing with fiat money, we could say that our money is based just on a cultural acceptance of it. Our money supply is built on credit, which hinges on peoples’ confidence in banks and banks’ confidence in their borrowers’ ability and willingness to service their debt.

We’re operating in a house of cards.

As confidence drains from the system, banks withhold credit, refuse to make new loans, and then demand repayment of any outstanding loans, shrinking the availability of money. The US economy, which has been fueled for decades by ever increasing doses of the twin drugs of credit and printed fiat money, could easily begin to drift into depression (defined as declining production, employment, and prices) with a reduction in our gross domestic product of 15 to 20 percent.

By way of comparison, in the Great Depression, our national GDP fell 29% over a four year period (1929-1933) and in that period we saw 7,000 banks fail and a 25 percent unemployment rate as the Dow Jones industrial Average suffered an 80 percent decline. And that was when the pain of a shrinking GDP was spread over 4 years!

Our fiat money is just a fantasy. That doesn’t mean it doesn’t exist, just that it consists of our belief in it. We just may witness the collapse of that belief, which would be very interesting to observe from a safe distance, if a safe distance were a luxury any of us had.

What should I do?

  • Pay off your debt with fiat currency before it’s completely worthless.
  • Learn to make extra money and make yourself valuable to your company to get paid what you’re worth.
  • Learn to garden … you may need it.
  • Repair what can be repaired and replace things only when they’re worn out.
  • Live significantly below your means.
  • Build stronger ties with your spouse, children, and extended family.
  • Develop customs and traditions that are inexpensive yet memorable.
  • Consider learning to make your own clothing.
  • Don’t be afraid to say no!

Sounds a lot like how our grandparents and great-grandparents used to live.

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