Saturday, August 08, 2009

What is Money and Why It was Created?

In my previous post - simple way to explain the economy, I clearly explained that why people want to trade not only for the benefit of 2 parties but SYNERGY. So, no way we can stop trading. Because of trading, economy exists and so does the money was created too.

A lot of people in fact has already forgotten or have no idea of what money is and why it was created? These are the 2 top answers that I get when I throw the questions out:

  1. Money is just a piece of paper.
  2. Money was created to make you rich.
I combine these 2 statements and it becomes:
  • Money is just a piece of paper to make you rich!
It sounds like money is magic because it is paper that can make you rich. Wow! Don’t you think so? But, are these answers correct? In some ways, perhaps yes?

What is Money?

Money is an agreement by everyone of us to be used as a medium of exchange. If you would like to use stone as your medium of exchange, then you can call the stone as money. Of course if you want to use a piece of papers as your medium of exchange, you can call this piece of paper as money. It was all started with stones, then gold, follows with coins and finally papers. But, why we want this medium of exchange?

Why Money Was Created?

The most direct precise simple answer is – money was created to make our life easier for the following reasons (that I can think of):
  • Goods are too Heavy - If I want to trade my cow with your chickens, I need to bring along my cow to you and carry your chickens back. Therefore, money was created to solve this. E.g. I just need to carry a stone instead of cow to make a trade.
  • Lack for Transferability - I have cow and you have chickens but you don’t want my cow and you want ducks. Then I need to look for people who have ducks that want my cow and exchange with them. Then, I only can use the ducks to exchange with your chickens. It goes very complicated when we involve more and more people. E.g. What if the one who has ducks wants only exchange with goats? So giving all this complication, a medium of exchange is defined which is called money.
  • Difficult to Divide - I have 1 cow and I want to exchange 10 chickens with you but the fact that you only have 4 chickens. On the other I want to have ducks as well but the one has ducks agrees only to exchange 7 of his ducks with 1 cow. How can I chop my cow to both you? It is difficult or troublesome to divide my cow. So, a medium of exchange is later invented.
To summarize all these, instead of saying money is a piece of paper to make you rich, technically speaking to be more precise - money is an agreement that everyone agrees to be used as a medium of exchange to make your life easier.

P/S: You may also want to read the Financial Big Bang Theory by Michael which I find it quite interesting on how the money was all started. I also like when he described the stranger house as bank.

Having said that, I don’t really sure if I agree when he mentioned the money is born due to the inconsistent trading. Can't we still define or standardize the trading agreement even without money existence?

I think money is born because the goods are too heavy (we don't want to carry them around) and trading with goods (i.e. technical term is known as barter trading) is lack of transferability and ability to divide.

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