This is s perfect place for me to ask this question. My child says, “hey, I understand we give people money and they give us food, clothes, games, etc., but how is it worth anything? What gives it its value?”
He’s 7.
I tried to say money represents labor or hard work, which he understands as having value. I tried to say something like, well when people had to look and forage for food all day, they didn’t need money. But then we invented farming, so other people had more time to do other things. So if the iron maker needed food and the farmer didn’t need iron what do they do?
I think I did a good job explaining the problem, but not answering the question. So, what gives money its value?
Thanks in advance. I’m in the US, but I think even in his young brain he wasn’t asking specifically about dollars, I think this is a more general question about currency. Like I don’t think this is about the gold standard or returning to it. I think it’s more about how a currency can get value along with a little answer to the reason why currency is necessary. Which is actually a pretty smart question. For a child.
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Money has value because everyone agrees it has value. I know that if you give me money, I can use it to get the things I need, and everyone I know will accept the money.
Your farming analogy is on the right track. Before money, people used the barter system, trading goods for other goods. One of the problems of the battery system is finding someone who has what you need **and** wants what you have, etc. But money had to be *invented*, so let’s carry the farming analogy through.
Let’s say you are a blacksmith and make horseshoes. You can trade horseshoes to get food, clothes, firewood, candy, whatever you need – as long as those people want horseshoes. If someone doesn’t have horses, your goods don’t have any value *to them*, so you need to trade something else. Maybe you find a third person who wants horseshoes and has something else to trade, etc. As you can imagine, this gets pretty inconvenient.
But what if you had something everyone needs?
Ok, this time let’s say you raise chickens, and everyone wants eggs. They’re good eating, so anyone can use them – in other words everyone *values* them. So you can trade your eggs for everything you need. But the people you traded eggs to can *also* trade them to anyone else. Maybe they hold onto a lot of eggs, carry them in their pockets, bring them to market, and so on. Now you have something that works a little like money.
But eggs are also really inconvenient – they’re bulky, hard to carry, and **fragile**. So someone comes to you and asks for an egg IOU. You draw a picture of an egg on a little slip of paper and agree that whoever has it can turn it in for an egg. They might ask you for more, and you draw a few Six Egg Bills and a Dozen Egg Bill and so on.
Congrats, you’ve invented money! Specifically an *exchangeable* currency. Now at the market people are trading your egg notes. They can carry a lot more in a wallet, and they aren’t accidentally cracking any eggs. Everyone agrees this works because 1) they can trade in the bills for eggs at your farm, and 2) everyone knows everyone else will take the egg bills, because everyone will want them.
This whole time you’ve been trading in people’s bills for your eggs, and spending your egg bills to buy everything you need, and it’s exhausting. Maybe one season you have an egg shortage and can’t keep up. Or maybe you just don’t want to be everyone’s egg bank anymore. So you tell everyone that you won’t exchange egg bills for eggs anymore at all.
So what happens? It’s it a catastrophe? Are all those paper egg notes worthless?
Turns out, everyone using your egg bills is using them way beyond what they’d every need for their own egg consumption. Workers are getting paid in egg bills, farmers sell grain for egg bills, the church is collecting egg bills in the offering plate, and the pub sells beer for egg bills. They really don’t care that the value of the bill is pegged to the egg, because everyone is using it for other things.
You still write egg bills. You pay for things in your egg bills, and sometimes you collect egg bills for the things you sell. Congratulations, you’ve made a modern paper currency.
In this analogy, you are the government. Eggs are gold (and sometimes silver historically), and egg bills are dollars. The government collects taxes in dollars, so nearly everyone needs at least some dollars. The government pays its employees in dollars and buys things it needs in dollars. And everyone agrees that dollars are valuable because everyone else will accept dollars for things.
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