We use our Money to buy goods and services, and that is what tells us the value of those products and services. But what exactly is the value of Money itself?
Today, while I was taking a walk around Sundhara to buy a few books for the holidays, I saw something very strange. At least it seemed very strange to me. People were selling Money for Money. Or rather, people were “exchanging” new Money for the old. I think the idea is entirely irrational, but for some reason, people seem to value new Money a lot more than the old one. And that got me thinking, how exactly is Money valued.
In this article, I want to talk about the following ideas
- What is the value of Money
- Role of credit and a story of how banking works
- Implications of the story and how the modern Banking system works
- How I personally look at money
What is the Value of Money
When we think of Money, we think of paper notes or coins which we use to buy goods and services daily. But it should probably amaze you that only about 10% of the “Money” in the global economy is physical currency. The rest of it is either digital cash or digital credit. Money in itself is imaginary. And at its core, Money is a social contract between people or an organization.
So yeah, depending on that social contract you can buy new money using old money. Or, we can simply trick ourselves into believing that the new shiny piece of paper has greater value than the old piece of paper.
Role of credit and a story of how banking works
A friend once asked me a straightforward question, and I couldn’t answer it accurately because there was a massive hole in my understanding of Money. I think this was because I discounted the work of credit in the economy. The question he asked me was, “if there is a small isolated village with a fixed amount of money already circulating, then how do you increase the amount of money in that village.” It’s a simple question that can help you understand the role of credit in the economy.
So let us think about this idea and use a story as a reference. (Concept from sapiens) Say in a village there is only a contractor, an entrepreneur, and a bank. The contractor, through all his hard work, has saved up 1000 Rs. He now wants to put the Money in a bank account for “safety.” The entrepreneur has recently had a great idea about opening an ice cream stand and making a lot of Money, but he doesn’t have any money for initial investments. So he goes to the bank and submits a great proposal influencing the bank to give him Money for his great idea. The bank has no money of its own except for the Money deposited by the contractor. The bank then lends the 1000 Rs. to the entrepreneur at a hefty interest rate with a hope to get a higher return in the future.
Now, the entrepreneur goes to the contractor and gives him the Money to build the ice cream stand. The contractor then takes the Money and again deposits it in the bank. After a few months, some unexpected thing happens and the cost of building the stand increases. At this point, the entrepreneur goes back to the bank and asks for more Money.
Implications of the story and how the modern Banking system works
The bank can do this again and again. And this concept of multiplying Money in the “financial world” is called the money multiplier. To know how this idea works, you can check out my blog on Inflation. But the idea is crazy and seems very counter-intuitive because there is a massive flaw in this model. The amount of Money in the economy hasn’t changed (which is still 1000 Rs.), but the total amount of Money flowing in the system is far greater and has the potential to go on forever. And I know you are probably asking the question, “what happens if the contractor asks for all his money back.” Well, the bank will collapse. The best it can do at that point is to pressure the entrepreneur to get the Money which, if you are following the story, is not possible.
Above, I described how the modern banking system works and has been working for a very long time. Scale up the above idea to millions of people, and you will understand how the modern banking system just doesn’t collapse every day. Also, there is the printing of Money and monetary policies which prevent these outcomes. But yes, in a theoretical sense, all the banks could collapse tomorrow if everybody wanted all their Money back.
So, most of what we think of Money is credit. You can think of credit as bringing future spending into the present. Instead of buying that phone in the future, you would instead buy it now using credit. It’s a way of creating imaginary future currency. And if you want to understand more about this topic, I recently wrote an article on how the economy works.
How I personally look at money
I stand by my claim that Money is the greatest and the most powerful work of fiction ever created. I see Money as a tool, like any other. Although a potent tool that helps to save time and buy resources. And time is the most valuable currency we have as human beings.
As we move towards a cashless society, I think we have to learn to detach ourselves from the emotional attachment we have towards Money. Research has shown that people are more likely to spend on a debit or a credit card then using actual Money. Our spending habits can be easily manipulated, and this is not a new revelation, supermarkets, and other stores have been doing this for years, using psychological manipulations to influence purchases.
At some point, I think we have to take the bitter pill and think about how we use our Money to understand how to use it properly, how to use it in a way that makes us happy instead of making us feel miserable about how we spend it. I say this because I think that the consumer culture is creating an ideology that wants to brainwash us into thinking that having more “things” makes us happy. “Things” do make us happy, for a while at least. But I think it’s the human experience that counts in the long run. The amount of time we can save to experience this experiment called life is the most valuable thing that Money can buy.
- Money has value because we all think it has value
- There is way more Credit compared to actual cash in the economy
- It’s crazy how the modern banking system works
- We should start seeing money as a tool and not as a means to an end