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.


Mt. said...

thanks for the mention.

there is also divide-ability, one goat is not easily divided into apples. Some may exchange at 100, another may ask for 200. so with money as a medium, it doesn't matter what the goods are. That way, it actually opened up the trades to the whole possibilities, instead of just TWO in goods exchange without money as medium.

recent China-Brazil bi-lateral trade agreement is an example of modern trade with 'NO' money ... or more precisely with NO USD ...

ChampDog said...

Thanks for the point. I will add that in as well.

It looks like modern trade now is moving back old times where no money is involved. :) Hahaha...

Alvin Lim said...

mmm i think money exists in the beginning to help ppl solve problems like heavy goods n stuff. but in the end, money creates more problems itself. :T

Andy said...

I can think of another reason for creating money.

Think of the workers of a country. They are going to demand the products their fellow workers are producing. As retribution for their work, they're given money which, as guaranteed by the state, will be useful for buying such things.

Why not give them the goods directly? Or other goods? It's not just the impracticality of transfer, it's also that those goods haven't been produced yet, and the other goods are being used elsewhere.

It's good to think about these fundamental issues from time to time, thanks ChampDog.

ChampDog said...

@Alvin Lim
This is a very good point. The original intention of the money creation is to help and make our life easier or comfortable but now is somehow involving to perhaps the evil part. Strictly speaking, the money itself is not evil or doesn’t create problems but it is all us to make it to become the evil one.

On the other hand, this is also important to remind us that the money is created to help us and not to give us trouble. So, we need to manage them and NOT to be managed by them. The sad thing is that majority of us that I have seen is managed by the Money honestly rather than managing the money – this including myself sometimes.

Thanks for the comment! Yes, if you give them the goods directly, how many type of goods you can give? So, at the end they still need to find a way to exchange their goods with something that they really want.

I think the fundamental is very important and that’s why I’m trying to blog about it and research on it. Perhaps I’m the beginner? But, I really do think that Money in fact is a very interesting topic. How many people today really understand what the money is and why we have it? I bet not many…

gezelle said...

very enlightening and entertaining, as always :)

ChampDog said...

Thanks! :)

Long time no see! How are you? Glad that you like the post. Thank you! :)

mindfinance said...

Money is means of exchanging goods and services. In fact, this money thing is actually invented in China, where they invented an IOU paper slip.

ChampDog said...

You're right. Paper money was started by China. Then later, the rest of the countries start following to use paper money.

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