Money is anything that is accepted as a medium of exchange for goods and services. Money is fungible and divisible and allows for an exact exchange of value between two parties in trade. Money stores value and can be used to save current value for future exchange or pay off debts from previous purchases. Money is a unit of account and a standard accepted for deferral of intrinsic value.
Before money was accepted as a means of exchange people bartered goods and services based on the needs of another trader and accepted value between two parties. Bartering was very inefficient and over time money evolved from this practice as beads, shells, spices, salt, gold, and silver started to be accepted as intrinsically valuable and used universally for trade. This made trade far more efficient.
Gold eventually evolved as a universally accepted unit of trade internationally and banking was built on the value of units of gold. Silver was also used for smaller value increments and both gold and silver were used with different sizes in coinage to make trade quick and easy with set face values.
Eventually, money evolved to where banks and governments started to issue paper bank notes and currencies on the gold or silver they held in their vaults. Large transactions were much easier with the use of paper versus carrying coinage or bullion and everyone accepted that the paper money was backed by the gold or silver it represented.
The United Kingdom’s pound sterling was the main international reserve currency for the world in the 19th century and through the first four decades of the 20th century until 1944 after it was bankrupted during the two world wars. Britain abandoned the gold standard in 1931 and the U.S. dollar started to gain dominance in international trade. The U.K. had to spend its gold reserves on the two world wars.
Before the two world wars countries backed their currencies with precious metals. After the financial devastation of the wars the United States dollar was established as the world’s reserve currency by the Bretton Woods Agreement in 1944. Countries pegged their currencies to the U.S. dollar after the war, ending the global monetary gold standard. Instead of holding gold reserves in their vaults, countries accumulated reserves mostly in U.S. dollars.[1]
In 1958, the Bretton Woods system became fully operational as currencies became convertible. Countries settled international balances in U.S. dollars, and U.S. dollars were convertible to gold at a fixed exchange rate of $35 an ounce. The U.S. had the responsibility of keeping the price of gold at a fixed level and was suppose to adjust the supply of dollars to keep confidence in future gold convertibility. [2]
President Richard Nixon closed the gold window in 1971 due to the nation’s inflation and to stop foreign governments from redeeming the U.S. dollars they held in reserve for U.S. gold. The Bretton Woods system ended after the continuous US balance-of-payments deficits led to foreign-held dollars becoming more than the U.S. gold reserves due to the over printing of U.S. currency. The United States could not fulfill its obligation to redeem dollars for gold at the official set price and the last remnant of the gold standard ended in 1971.
In 1971, the last connection of national currencies to something of intrinsic value ended and they are now only backed by the government’s endorsement and enforcement. All national currencies are now fiat currencies and their extrinsic value comes from the government making them legal tender for all debts public and private and can be used to pay taxes. Modern currencies are not backed by gold, silver, or anything else. National currencies’ values are now primarily measured against each other, versus gold, and their buying power for importing and exporting goods and services between countries.
The U.S. dollar has remained the world’s reserve currency as it’s backed by the power and stability of the U.S. military and the extrinsic value it holds with what you can buy with it in the U.S.
Who created the concept of the money illusion?
The term money illusion was first coined by economist Irving Fisher in his book “Stabilizing the Dollar.” The famous economist John Maynard Keynes is credited with bringing the term into mainstream academics.
Money illusion explains that people have a tendency to see their wealth and paycheck in nominal dollar terms and not recognize the real value of the currency adjusted for inflation over time.[3]
What is money illusion example?
Older managers and supervisors don’t adjust what they are paying new workers in inflationary terms and tend to have a set amount that they think is a good pay rate over decades. This is due to the money illusion.
A home seller doesn’t understand the bulk of their home value increase over decades is primarily due to the replacement cost of their house caused by inflation. Historically, over a 20 to 30 year period most housing prices rise due to inflation and misunderstanding the gain must be adjusted for inflation is due to the money illusion.
Is the concept of money real?
Wealth is in the ownership of businesses, cash flowing assets, land, real estate, commodities, and resources. Money is simply a unit to measure the value of real assets. Money is only as good as the trust people have in it to use it for transactions and storing value. Money is real to people that believe in its extrinsic value for exchange.
Is money an illusion?
Money is a medium of exchange accepted by almost everyone in a country including businesses and government. The value of money over time is the illusion as the U.S. dollar tends to decline by 2% in purchasing power per year on average. Money is a wasting asset and the value of a currency over time is the illusion not that it can be used in transactions. Another illusion is that currency is not an asset, it’s debt issued by central banks in return for assets.
Technically, a Federal Reserve note is a promissory note that does not pay any interest. It’s defined this way because it states that “this note is legal tender for all debts, public and private,” indicating a promise for the U.S. government and private citizens to accept the note as legal tender. [4]
A Federal Reserve note is an IOU from the Fed to its bearer that doesn’t pay interest. It’s a liability on the Fed’s balance sheet. The Fed’s capital is equal in value to the difference between its assets and liabilities. [5]
What is the paradox of money?
The Money Paradox is that money itself isn’t wealth it’s just a unit of measure of wealth. It’s a financial tool for executing transactions and quantifying value of physical assets. The only value of money is what it can purchase, the value it can store for later use, and its ability to set prices for assets. The wealthy don’t hold their net worth in currency they hold it in assets, few understand this. When you hear the net worth of a billionaire it is usually the value of the shares of stock in their company they still own not how much money they have in the bank.
