Oxford Dictionary

Money — [noun] A current medium of exchange in the form of coins and banknotes; coins and banknotes collectively

ELI5

Money – we use it everyday and barely think about it other than trying to figure out how much to tip the waiter or how much to pay a roommate for rent. It is an object that has some agreed upon value and can be used to exchange for other goods or services.

In the old days, the barter system was the primary form of getting your groceries. I’ll give you 5 bananas for 10 apples. Now, let’s say you are looking for some rope as well, and the craftsmen will only accept onions. You have the 5 bananas I gave, but they are useless in this situation, and without this rope…things aren’t looking good for you. This is where money comes in — it acts as a middle-man by everyone agreeing that it is of some worth and can be easily exchanged. One note – apples, bananas, and onions are all forms of money actually, but they are considered commodity money.

Now let’s switch the previous example to coins. I’ll pay you 20 coins for the 10 apples. The rope is only 10 coins which you can directly give the craftsmen instead of trying to find these precious onions — it makes the whole system much more efficient. In the case that the rope is higher quality — you might have to pay 15 coins, thus the price in coins indicates value of the good as well.

Detailed Definition

Money ultimately has three major purposes in the world today: medium of exchange, value indicator, store of value.

Commodity Money

We most commonly think of money as (typically) round pieces of metal or paper notes containing some inspiring or historical information about a country or government. Several millennia ago, farmers would utilize their surplus to trade for other goods. The grain or wheat that they would trade for fruit and vegetables is a form of a different type of money called commodity money — since the item being used as money has significant intrinsic value. Traveling from one area to another with a cart full of grain or livestock only to haul back some other unwieldy good proved inefficient and inconvenient. There are still many downsides to a commodity based coin system since the worth of the coin is inherently tied to the commodity it is comprised of.

Permanent Store of Value

King Alyattes of Lydia (modern day Turkey) was likely the first to introduce a coin based system of money. The coins contained a lion’s head emblem providing guarantee of value by the government and a level of accountability. The Lydian staters, as they were known, were composed of electrum – a naturally occurring gold-silver alloy diluted by copper which actually gave them the gold hue. Both gold & silver are trusted and valued commodities so people had faith in the coins retaining a more permanent store of value. This was extremely convenient compared to commodities – imagine several silos containing your surplus of grains getting spoiled due to a large flood, etc. The stater were easily transported and could be stored in a safe place to protect against weather or robbers.  

Value Indicator

Another critical aspect of this system was that each coin was standardized to a weight of about ~220 grains of wheat. When going to the market, a farmer didn’t have to spend time weighing gold and silver ingots as done before coinage was developed — a merchant knew that the Lydian stater represented this fixed amount providing an indication of value.

Lydians are the first known group of people to use a coins, but similar systems were developed in China [necklaces with bronze pendants — essentially creating a wallet while also showing off how wealthy you are] and India [where shells were used instead of coins].

TRANSITION TO FIAT MONEY

The next big transition in money comes during the transition of commodity money to representative or fiat money. Fiat money holds no significant intrinsic value unlike a commodity — a copper-plated zinc coin (i.e. a penny) or rectangular piece of paper with values and pictures printed on them isn’t worth more than a few cents. However, when the government issues these notes and decrees “This note is legal tender for all debts, public and private,” it makes things more interesting. If the entire US government sees these pieces of paper as worth some value — businesses and individuals are more incentivized to use them.

In fact up until 1971, in the US every dollar was backed by some gold or silver by the government. This forced the government to accrue a larger supply of gold whenever it had to print out more notes — self-limiting the supply of currency. That means based on the price of gold or silver, you could exchange a certain amount of your greenbacks for a physical commodity. After 1971 when Nixon officially seized the ‘gold standard’, that piece of paper can’t be exchanged for anything — but since such a large quantity is in supply today and widely accepted as a form of exchange with a store and indication of value it’s challenging to imagine it not being worth anything.

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