By Ricardo Testori on The Capital
Most people think that money is notes and coins, but only about 20% of spending is in cash — most people use a credit card or buy online for their personal shopping. Overall, when we include government and business, more than 90% of spending is done electronically. Another name for cash is “currency,” and there are different types around — mostly from different countries.
So what is it we’re spending? And also importantly, what is it we’re earning?
A good description of money is that it is a means of exchange. This applies whether the transaction is with notes, coins, credit cards, or a computer entry. When we buy or sell something, the value is in the things we are arranging to transfer between us. For example, you could be offering to do some work for someone to buy food or clothing (or whatever) to live. You probably wouldn’t want to do that work if you didn’t need anything. So money provides the means to exchange your time (now) for something else you need (later).
The money has no value of its own — it is just a bit of paper or a line on a bank statement. But that piece of paper (or the last number on the bank statement) can be exchanged for something of value — like food or clothing.
Why does everyone accept money if it is worthless? Oh, I didn’t say it was worthless, I said it doesn’t have a value of its own. There is no gold sitting in a vault somewhere that backs up the value of money, but you could use money to buy some gold if you wanted to. Once upon a time, there WAS gold held in vaults (like Fort Knox) to give money its value, but Richard Nixon worked out (in 1971) that it wasn’t necessary. He understood that everyone would continue to use the same money without the gold to back it up. And he was right. And we do.
Back in the old days, when there was gold backing the currency, they had a promise printed on the notes that said the note could be exchanged for gold. Since 1971 that promise has changed — now it just says you can exchange it for precisely the same value as the value printed on the front of the note. So the government promises to pay you $10 if you give them a $10 bill. Gee, thanks!
At this stage, you may think this is all a bit silly, but now I’ll show you why it makes sense. The reason is that most people OWE something to other people. But everyone, eventually, owes something to the government — usually taxes — and they are saying that they promise to accept your money to reduce what you owe them. Not only that, they won’t take anything else but their money! You may consider your Frequent Flyer Miles to be of value, but the government doesn’t. They wouldn’t even accept your stamp collection — until you’d exchanged it with someone else for their money. So the promise means something. Although the promise is only printed on the cash notes, it is transferable to other forms of money — such as coins and bank balances.
So money is just a promise from the government to accept their own money back so you can pay them what you owe them. And if it’s good enough for the government, it’s good enough for everyone else. We all agree — most of the time — to accept the government’s money in payment for what is owed to us. Even if we decide to use something else for the exchange, we usually need to agree on its monetary value as well.
Now we know what money is — it’s a promise. But where does it come from?
There are two primary sources of money; one is the government, and the other is the banks. The government has a special arrangement with the banks for them to help manage the use and security of money. They even allow the banks to create money under certain circumstances, but this is only for electronic money, and the banks are not allowed to print or copy the government’s cash. The money which the banks create is of a temporary kind; it starts as a loan and disappears when the loan is repaid. When the bank lends money to a customer, it doesn’t need to have notes and coins in its vault to back up that loan; the whole thing is electronic.
The real source of money is the government, and they hold the monopoly for doing this. They have strong laws to prevent anyone from making copies of their cash (counterfeiting), and the laws are strong enough that we all trust that the cash we use is genuine. But only a small part of our money is in the form of cash because the government usually spends electronically. This money goes around and around, from person to person, between businesses, and eventually back to the government when taxes are paid.
So what about the money you earn at work, you would think that it’s coming from your boss — right? But where does he get it from? Usually, from his customers, then most of it gets spent, and just a little bit ends up in your pay packet. But he didn’t CREATE that money, he (or his business) earned it, and the same goes for his customers. The only exception would be if the government were one of his customers, they are the only ones who can create money. In some cases, the government could pay you directly — you may be a government employee or receiving some benefit. But the same rules apply, you can’t create the money yourself.
Now, this next part may be a big leap for you! Remember how repaying a bank loan wiped out that part of the money created by the bank. The money just ceased to exist on any account; the balance was zero. Well, the same thing happens when the government gets paid for taxes, the money disappears! The promise has been made and kept.
Luckily, not all of our money gets paid on taxes, and some is left over — that’s our money! It’s our cars and homes and food and clothing — everything we spend money on or save. But let’s be very clear, all of the money which ends up in our hands (or our pockets or bank statements, all of it) has come from the government. It gets to us because the government spends it. Then they take some back in taxes, but the difference between what they spend and what they collect in taxes is ours. And, in most cases, we’ve earned it.
There’s much more detail to understand about how the government spends and taxes and budgets, but that’s a story for another day. Now, if anyone says, “You don’t know what money is,” you can stop them right there and tell them what I’ve just told you. And enjoy it! For a more in-depth understanding of money in our world, see the links below.
Prof Richard Murphy, Professor of Practice in International Political Economy at University of London: