Sunday, September 13, 2009

What Determines the Value of Money?

We invented the money as medium of exchange but how are we going to determine the value of money? What do we mean by $1? What do we mean by $100? Who is in charge of determines the value of money?

The value of money has really no meaning at all until we know what is the capability or we call it purchasing power. Technically speaking, only goods or services has value and whether how much the goods or services are worth to you are very subjective from one person to another. Eventually, it is still back to the basic fundamental of economy, supply & demand to determine the value of the goods or services. Let's look at some history how we determine the value of the money...

Very Brief History of Money

Before paper money was introduced, money used to have its value when gold was still used as money (e.g. coins that made by gold). Then later the paper money was introduced to represent the gold. Thus, the Gold Standard Act was introduced, let's say $100 represent 1 ounce of gold. Having $100 is equivalent having 1 ounce of gold. You can basically exchange your $100 with 1 ounce of gold anytime as you wish. This is what it means by “Money is Backed By Gold”. So at that point in time, the value of money is determined by how many the gold you have.

The gold standard was then lasted until 1971 when “Fiat Money” was introduced. The key concept of “Fiat Money” system is money is no longer backed by any commodity (i.e. gold). This is the system that we're still using until today and it is totally based on our confident on the money itself. In other words, the value of money is now determined by your perception, impression or confidence on it. As long as WE THINK, how much money is worth, the money will worth that much. Of course, the “WE” here is not you and me but “EVERYONE” in the globe.

Simple Version (I hope) of Money History

  1. Everyone used gold as money (i.e. medium of exchange).
  2. Bank came out a standard way to represent the gold (i.e. coins)
  3. Coins too heavy to carry around, bank introduced paper money to represent gold (i.e gold standard).
  4. Later on, we all confused with this piece of paper is valuable. We forgot that the paper money has value because it is backed by gold. We all started to love money...
  5. Bank created more paper money to satisfy our needs even without the actual gold they have.
  6. Sooner or later, money was no longer backed by the actual gold. “Fiat Monetary” is born.
  7. “Fiat Monetary System” works until today which means the money now gains its value through our impression and perception.


Money in fact is a very complex topic and until today I'm still learning a very basic question of money: What is money? How money works? I try my best to make it as simple as possible.

To summarize this in few words, the value of money was used to determined by actual gold. However until now, the value of money is getting more complex in a sense that it no longer tights to gold but our impression or perception toward the money. That's why according to economist, only 8% of the world's currency exists as physical cash.

P/S: I talked about perceptive reality few years back and now this topic kind of links it back although my original intention has nothing to do with money. Think of it again, can I say the value of money is perceptive reality?


Michael Tsen said...

money is a 'numbering system' that represent values of all the things we need and want. By itself, it has no value whatsoever.

ie. the values of a valuing system has no value by itself.

If I can get what I need directly, I do not need the intermediate medium - money.

the same goes to gold. Gold itself has no value if not we human made it so. If we choose oxygen as the standard of money and not gold way back then, perhaps today we would value oxygen more than gold now.

ChampDog said...

You can't make oxygen as money because you can just breath anywhere as you like. Think of it from financial perspective, oxygen is really has no value at all. Unless one day the whole world is lack of oxygen...

Based on what you have said, it looks like, there is something wrong with the world? No?

1. Oxygen has value, but we don't value it.
2. Money/Gold has no value, but we value it.

Anyway, this is my definition of value:

1. Money has no value because we DEFINE money as medium of exchange.
2. Everything that is not medium of exchange has it's own value - including gold.

How does that sound?

Kris said...

Money has value only because we ourselves give value to it.

ChampDog said...

As I said, money doesn't have value because it is used a medium of exchange. If gold is used as medium of exchange, gold has no value as well. Other than that, everything has its value.

We give value to money is because the money is used to represent the stuff that you can buy. In fact, you’re actually giving value to the stuff not the money.

Alvin Lim said...

Whoa, very good post even though it is a bit complex for my level. For someone who knows nuts bout money, this is indeed complicated. Hahha. But what you said is true, money is only valuable because we think it is.

ChampDog said...

I had been reviewing and simplifying as much as possible from my original post. In fact, my original article is even longer and complex. I think I rewrote at least 3 time to throw away any unnecessary points but obviously, I still have a lot rooms of improvement. :D

Michael Tsen said...

abt ur 2 definitions ...

if a ruler measures length, does the ruler has length itself ?

my poop is not a medium of exchange, are you sure it has significant value thats worth identifying ? Which btw already flushed away ...

ChampDog said...

I was looking at the different perspective that money has it value because it is used to represent the value of something. Other than that, there is no value of it. Value here is not the numbering but something that how much it worth to us.

But you brought up a very good point that the ruler has it's length as well. Everything has value including money as well. Is this what you're trying to say?

I guess this is getting more confusing which I have no intention. How about the following generic definition below? This is my original message that I want to bring out in this article.

Value of Stuff (Including Money) = Our Impression Towards the Stuff

Does the equation make sense?

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