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What Is Money II: Two Kinds of Money - Lifestyle Articles - Love Ambassadors Ministries

WHAT IS MONEY II: Two Kinds of Money

Source: Investopedia.com

In our previous (first) article in this What is Money series, we looked at Trade by Barter and the problems associated with it. We saw that the problem of divisibility and transferability of goods arose every time when goods were to be traded by two individuals.

To solve these problems came commodity money, which is a kind of currency based on the value of an underlying commodity. Colonialists for example, used beaver pelts and dried corn as currency for transactions. These kinds of commodities were chosen for a number of reasons.

They were widely desired and therefore valuable, but they were also durable, portable and easily stored.

Another example of commodity money is the U.S. Currency before 1971, which was backed by gold. Foreign governments were able to take their currency and exchange it for gold with the U.S. Federal Reserve. If we think about this relationship between money and gold, we can gain some insight into how money gains its value: like the beaver pelts and dried corn, gold is valuable purely because people want it.

It is not necessarily useful, after all you can’t eat it and it won’t keep you warm at night, but the majority of people think it is beautiful and they know others think it is beautiful. Gold is something you can safely believe is valuable. Before 1971, gold therefore served as a physical token of what is valuable based on people’s perception.


The second type of money is fiat money, which does away with the need to represent a physical commodity and takes on its worth the same way gold did: by means of people’s perception and faith.

Fiat money was introduced because gold is a scarce resource and economies growing quickly couldn’t find ways to mine enough gold to back their money requirement. For a booming economy, the need for gold to give money value is extremely inefficient, especially when as we already established, value is really created through people’s perception.

Fiat money then becomes the token of people’s apprehension of worth – the basis for how money is created. An economy that is growing is apparently doing a good job of producing other things that are valuable to itself and to other economies. Generally the stronger the economy the stronger its money will be perceived (and sought after) and vice versa.

But remember, this perception although abstract must somehow be backed by how well the economy can produce concrete things and services that people want.

That is why simply printing new money will not create wealth for a country.

Money is created by a kind of a perpetual interception between concrete things, our intangible desire for them, and our abstract faith in what has value. Money is valuable because we want it, but we want it only because it can get us a desired product or service.