How Money Works

Everyone talks about money and everyone is in need of money. There is hardly anything one wants to do that doesn’t involve money. But not everyone knows how money works.

That is why some don’t know how to manage it or even multiply it. If money is very important in every society then we ought to go beyond just making money and spending it.

We ought to know how money works, as this could further help in making saving and investment decisions for anyone.

What is Money?

Money is a means of exchange and a store of value. Money has worth solely because people agree to value it. Although currency and financial accounts have no intrinsic value, money becomes valuable when everyone decides to use it.

It can take several forms, including cash, balances in commercial bank accounts, and time deposits such as certificates of deposit (CD).

Money is a commodity that serves as a medium of exchange in business operations. Money is traditionally described as a unit of account, a store of value, and a medium of exchange.

It operates on the basis of widespread recognition of its value both inside the government and abroad through foreign exchange.

The current worth of monetary currency is not always determined by the resources employed in its production. Value is rather derived from the desire to accept and depend on a displayed value in future interactions.

Money's main function is to serve as a universally recognized medium of exchange that individuals and world economies plan to keep and recognize as payment for present and future trades.

All transactions would have to be handled via barter, which includes the direct exchange of one commodity or service for another in the absence of money.

The problem with a barter system is that in order to get a certain commodity or service from a supplier, you must also have something of equal value that the supplier wants.

What is the Barter System?

Barter is the exchange of products or services between two or more persons without the use of money or a monetary means like a credit card.

In short, trading entails one party providing one good or service in exchange for another party providing another good or service.

Bartering is founded on a basic concept where two people discuss the relative value of their commodities and services and then exchange them in an equal exchange.

It is the oldest method of exchange, stretching back to before the invention of actual currency.

The current elderly generation bartered with the limited goods they had on hand, such as produce and livestock, or services they could personally render to someone they knew, such as carpentry and tailoring.

Most Americans now have access to a nearly limitless pool of potential bartering partners thanks to the internet. If both parties agree on the terms of the deal, almost any goods or services can be bartered.

Individuals, businesses, and governments can all benefit from cashless transactions, especially if they don't have enough hard currency to buy products and services.

Only a double coincidence of wants between two transacting partners allows for exchange in a barter system. However, the chances of a double coincidence of wants are slim, making the exchange of products and services difficult.

Money successfully solves the double coincidence of wants problem by acting as a medium of trade that is accepted in all transactions and by all participants, irrespective of if they want each other's goods and services.

Characteristics of Money

A currency should have specific features in order to be most useful as money, which includes the following:

• Fungible. The quality of the units of the good should be somewhat consistent so that they can be interchanged. If multiple units of an item have varying attributes, their value in future transactions may not be constant or dependable.

• Durable. The physical characteristics of the good should be durable enough to be utilized several times and retain their utility in future exchanges. A perishable item or one that degrades rapidly after being used in exchanges will be less usable in future transactions.

• Portable. It ought to be broken into small amounts so that people recognize the initial use-value enough so that a useful quantity of the good may be carried or transported easily. An indivisible, immobile, or low-original-use-value good can cause problems.

• Recognizable. The authenticity and quantity of the good should be readily ascertainable to the users so that they can easily agree to the terms of an exchange. Trying to use a non-recognizable good as money produces transaction costs of agreement on the authenticity and quantity of the goods by all parties to an exchange. 

• Stable. The value that people place on a good in terms of the other goods that they are willing to trade should be relatively constant or increasing over time. A good whose value varies widely up and down over time, or consistently loses value over time is less suitable.

Functions of Money

Money serves largely as a medium of exchange. However, because of its usage as a medium of exchange, it has gained other uses.

The other functions of money include;

1. Unit of Account.

Money can be used to monitor money gained or lost all over transaction records and to make comparisons of money values of various combinations of various quantities of different goods and services mathematically as a result of its use as a medium of exchange for both buying and selling and to designate prices to all sorts of other goods and services.

Accounting for a business' profit and loss, balancing a budget, and valuing a company's overall assets are all achievable because of this.

2. Store of Value.

Money's utility as a medium of exchange in transactions is essentially future-oriented, thus it can be used to store value generated through present production or trade for future usage in the form of other commodities and services.

People can store the worth of their non-fungible, non-durable, non-portable, non-recognizable, or non-stable commodities or services by trading them for money in the present.

This makes it easier to save for the future and conduct transactions over large distances.

3. Standard of Deferred Payment.

Money can be used to move value for trade usage at different periods between people through the instruments of credit and debt to the degree that it is acknowledged as a widespread medium of exchange and serves as a valuable store of value.

A person can lend a certain amount of money to another for a specific amount of time and then repay the loan with another agreed-upon amount of money at a later date.

The lender transfers the stored value represented by the lent money to the borrower in exchange for an agreed quantity of stored value in the future.

How Does Money Work?

Another key aspect of money and the economy is how a country's central bank, which is the Federal Reserve or the Fed in the United States, can affect and manage the money supply.

Of course, the Fed can print money if it wants to expand the amount of money in circulation, perhaps to encourage economic activity. Physical bills, on the other hand, make up a modest part of the money supply.

The central bank can also raise the money supply by purchasing government fixed-income securities on the open market.

When the central bank purchases government securities, it essentially puts money into the hands of the general population.

How can a Central Bank like the Federal Reserve pay for this?

The central bank, as weird as it may sound, just generates money and distributes it to those selling securities.

Meanwhile, the Fed might reduce interest rates, allowing banks to offer low-cost loans or credit. Cheap money is a phenomenon that encourages companies and individuals to borrow and spend money.

The central bank sells government securities in order to reduce the money supply and maybe control inflation. The money that the buyer uses to pay the central bank is effectively removed from circulation.

Bear in mind that a central bank may print more money as long as people believe in it. However, as with anything with a bigger supply than demand, if the Fed prints too much money, the value will fall.

As a result, the central bank can't just generate money whenever it wants.

Cryptocurrencies

Cryptocurrencies, such as bitcoin, are peer-to-peer money. This electronic money is based on electronic accounting entries and can be used as a means of exchange. Many aspects of both market-determined money and fiat money may be found in cryptocurrencies.

Cryptocurrencies began as accounting units given to users in exchange for assisting in the processing and verification of transactions on a cryptocurrency blockchain.

They've also evolved into a new type of coin offering that can be used to fund new technological business efforts and companies. Cryptocurrencies are becoming increasingly popular as a means of exchange for everyday transactions.

To make money, some people may have to get a job, get interviews, pass the interview questions and start earning a big salary. How to answer interview questions is very important here because it is how to earn money. And this is also linked to how money works.