What is money? Sometimes the easiest questions are the hardest to answer. So, what is money? We use money every day, but what is it really?
By its simple definition, money is a medium of exchange. Money is merely a method of transferring some sort of value from one person to the next. When studied, money tells one of the longest stories ever told about human history. And, if thinking about it in this way, currencies are the voices that tell the story. A currency simply brings the theoretical concept of money to life. For this to work, a currency needs to fulfill several characteristics : durability, portability, divisibility, recognizability, and limited supply.
For thousands of years, humanity used gold as the voice to tell our story. In fact, gold made a great currency! It is rare and can’t be reproduced, it has a low density so that it can be easily transported; and gold is fungible, meaning one ounce of pure gold equals another ounce of pure gold.
The evolution of innovation is one of the most important factors in the journey of humankind.
While gold was good enough to represent a storage of value and facilitate barter, people looked for a more convenient system. They found it in paper money pegged to gold. The concept was simple: You give gold to a bank, and they issue a document called an IOU ( “I Owe You”), which you can take and use in the real world just like you had used gold before. And that’s how money became paper!
Here is the US dollar, the world’s largest currency. (take a dollar bill out and show it to the camera) Look at it, the US dollar is an international representation or symbol of freedom, capitalism, and prosperity. But now, ask yourself, what’s it really worth? What intrinsic value does that thing in my hand hold? To some extent, this piece of paper represents a written contract between you and the U.S government that indicates the government owes you the value of that dollar bill.
Well, let’s travel back in time to 1944, when the second world war was coming to an end and the United States held the United Nations monetary and financial conference, where a new financial system was to be created in order to stabilize the world’s finances after the war ended. The US dollar was chosen as the world’s reserve currency. Rather than use gold as the direct means of exchange between countries, the US dollar was chosen as the world’s reserve currency, because–back then–it was as good as gold. Under this new system, countries agreed to fix their currency to the US dollar, and the US dollar would be tightly tethered to gold at a price of $35 an ounce. This meant that countries around the world could trade their currencies for the US dollars, which could then be exchanged for gold. This created a system where all currencies were essentially backed by gold. And all that gold was stored safely in the US. The foreign central banks could redeem the US dollars for gold when they wish, at least in theory, of course.
And then, the spending began! With the dramatic increase in spending, the US government began running fiscal deficits. There were more dollars printed than could be backed by gold. And foreign countries rightly noticed the devaluation of the US dollar and started demanding gold to be shipped to them. And then, in 1971 president Nixon summarily suspended the convertibility of the US dollar to gold, thereby disconnecting the US dollar from the so-called “gold standard.” This was an attempt to save the US currency domestically and abroad and to allow governments to exercise better control over inflation and deflation by managing money circulation.
Suddenly, any central bank could increase or decrease the money supply at will. Money became a commodity. This new type of money without any pegging to gold became known as “fiat money.” We now have a completely new scenario. Since trusting the connection to gold is off the table, now we have to put that trust in the hands of a central authority to take care of this fiat money and make it a stable and trusted store of value.
This reveals a central challenge: how to design a system that most effectively facilitates the exchange of goods and services and generates prosperity while preventing the institutions that manage that system from abusing the trust that comes with that role.
Recently, governments have drastically increased the amount of money they print and pour it into circulation. Since 2020, the US has printed nearly 80% of all US dollars in existence. Let me repeat this one more time: The US central bank created 80% of its fiat within the last 22 months. The repercussions of this action are tremendous: the store value of money is compromised and anyone dependent upon the dollar to store its value is victimized. The US inflation rate rose to a staggering 6.8% in 2021. And while it is true we want items and products that meet basic human needs and serve social functions or represent an investment vehicle, such as housing, to appreciate in value, we must understand the pressures and market conditions that cause the increase in the perceived value of these products or commodities, such as grains, metals and the like, as well as practical investment vehicles, like dwellings. For example, if you buy a house for $200,000 and, over a short period of time, it is rather suddenly valued at $300,000, you might think this is a good thing. It might look that way, however, the mechanism by which this is happening is important. Your house is increasing in value not because consumer demand drives the appreciation solely but because there is an increase of artificial supply of fiat currency that, in turn, diminishes the fiat’s ability to store value.
Look, topics of economics can be very difficult and overwhelming to understand. I will be making more videos to break them down for you in a simple manner.
Simultaneously, we must recognize the emergence of a new currency–digital currency. While the concept is still new , it has a huge potential. With the growth of technology and its extension into every aspect of our lives, digital currency has a lot to offer. Watch my next video to learn more about cryptocurrency and how it can be used in day-to-day life and become the next voice that tells the human story.