How does currency work?
In: 1
Currency is like tokens you get at an arcade.
1. **Creation**: Just like the people who work at the arcade give you tokens, there’s a group of people in each country that make money. In the US, this group is called the Federal Reserve.
2. **Distribution**: The money they make gets sent to banks. Just like when you get tokens from the counter at the arcade, you get money from banks.
3. **Use as a Medium of Exchange**: Now, you can use these tokens, or money, to “play games”, or in the real world, to buy things like toys or ice cream. The amount of tokens each game needs at the arcade is like prices in a store.
4. **Store of Value**: You can save tokens to play a big game later, right? The same way, you can save money to buy something big in the future.
5. **Unit of Account**: Just like you know some games cost more tokens than others, money helps us understand what things cost compared to others.
6. **Digital Currencies and Cryptocurrencies**: Imagine if the arcade had a special kind of token that only works with certain games. That’s kind of like digital money or cryptocurrencies like Bitcoin, which are a different type of money that we use on computers.
Just like you trust that your tokens will let you play games, people need to trust that money will let them buy things. That’s how money works!
This is a broad subject enquiry. There is a history of currency etc but for ELI5 and reasonable comment length, just the modern version. If you want to study the history of currencies, this is fairly easily found (wikipedia, maybe even youtube videos). The study of value etc is done in economics. Basic value and exchange theory in microeconomics and currency, banking etc in macroeconomics. Economics, as a subject, can be introduced as early as late secondary education (16-17 years old) and can be studied in university up to doctorate levels. There are professional economists.
Modern currency. Nearly every country has a government that issues legal currency. This is a mandate that a certain item (dollars, peso, yen etc) issued and controlled by the government MUST be honored as a means of exchange (ie buying and selling) WITHIN THAT COUNTRY. Also any payment to the government (taxes etc) and receipts from the government will be in that currency.
In modern economies, it is nearly impossible for any person to produce all that they require (food, shelter, clothing etc). People tend to specialize and trade for what they need. Money is the vehicle for trade and governments control and issue them to ensure that their economies grow and people can obtain goods that they want.
Bottom line: people want and need stuff. Most people cannot make all the stuff that they need. So they exchange their efforts for the stuff that they need. Money is the exchange mechanism. You earn money through a profession/job and spend money to buy stuff.
Currency is a unit of exchange and a store of value.
A unit of exchange means it’s how you measure stuff. One *dollar worth* of beef is a specific amount of beef, one *dollar worth* of gold is a specific amount of gold. Trade is denominated in these units. People are always exchanging various goods, and denominating the amounts of the goods in some currency, like dollars, euros, yuan, etc.
A store of value means it is value that you can put under your mattress or in a drawer for a while and it’ll still be valuable later. It doesn’t go rotten like food does, and it doesn’t require a lot of upkeep or maintenance to keep it in good condition. So your wealth can last a long time if you keep it in currency, rather than in something more vulnerable like livestock, or bushels of wheat.
– Currency works because people agree to accept it as a medium of exchange for goods and services.
– Governments create and regulate “fiat” currency to ensure its stability and usefulness.
– Fiat currency’s value is derived from the trust and confidence people have in the government that issues it.
– Governments declare fiat currency to be legal tender, meaning it must be accepted as a form of payment within the country.
– People accept currency because it is widely recognized and trusted as a form of payment.
– Currency has value because people believe it can be used to buy things they need or want.
– The value of fiat currency is regulated by the government through monetary policy, such as adjusting interest rates or controlling the money supply.
– Accepting currency makes trading and buying things easier and more convenient.
– Currency is backed by the trust and confidence people have in the government that issues it.
– Currency allows people to save, store, and transfer wealth easily.
– Businesses accept currency because they can use it to buy resources, pay their employees, and invest in their operations.
– Currency provides a common standard for pricing and helps in comparing the value of different goods and services.
By mutual agreement.
Depending on the economic system, it *might* be something akin to a governmental promissory note that allows access to something valuable but inconvenient to carry around in quantities needed for buying stuff (like precious metals), but most countries today use something called fiat currency.
Something that usually blows people’s minds: Money is a social construct. It only exists by our mutual agreement that it exists, and it has value because of our mutual agreement that it has value. And the “we” here is a gestalt societal unit – there may be some individual holdouts who won’t do any business outside of bartering their fruit for goods or services directly, but this doesn’t happen in great enough numbers for it to affect the value of the currency in the vast majority of cases (and when it does, you end up with things like the great depression)
People agree that this paper printed by the government is worth value, and they trade stuff for it because they fully believe that the next person will accept it as well. So I can work at what I do and get the paper and trade it for things I need and want but did not create myself.
Lets use the intuitive example of gold. A person is willing to get paid in gold because it has an agreed-upon value and thus can be used to purchase goods or services. The purchase is just an exchange (“my gold for your car”). This works because everyone agrees on what the value of gold is.
Now if you get paid and then use that payment for a purchase, the gold served really only one function: a store of value. In this case, it doesn’t matter what the currency itself is made of, it could be monopoly money, it could even be digital these days…as long as it has an agreed upon value, and it has a controlled supply by a governing entity for stability. That is, it cannot be created out of thin air or found in nature. Which is why gold isn’t even a great ‘store of value’ item since it isn’t as easy to control its total supply. Also it has to be something that lasts, so something perishable, while technically could work as currency, would not make much sense.
Latest Answers