The Meaning of Money

Let's say that you have something that I want, such as a sucker. I don't have any money to buy the sucker from you, but I do have two pieces of gum that you want. So we trade, or barter. That's how human beings first developed their economies.

But let's say you didn't want my two pieces of gum and that I had nothing else to offer for the sucker. Guess what? I don't get my sucker. I'd have to find someone else who has a sucker and is willing to exchange it for my two pieces of gum. Or you and I would have to find some other thing of value to us both. This is where money, a medium of exchange, enters the picture. Over the centuries, people have developed coins and currency to exchange for goods. Thus, if you don't accept my two pieces of gum for the sucker, you would accept my quarter because you and I and everyone else in our society accept that our money has value. You in turn take the quarter and buy what you want, say a couple of jawbreakers, from someone else.

Money is valuable because people accept it as being useful, even though money is just pieces of paper and metal. But money is not indestructible because over time inflation (rising prices) can eat away at its value. Most government and financial institutions, however, do try to control as best they can the rise in prices. Even under extreme circumstances people will live by the power of money.

The American Federal Reserve System of Federal Reserve Banks is one of the government institutions that attempts to control inflation so that we Americans will continue to accept our money as having value. According to the Federal Reserve Bank of Minneapolis, money has three functions:

          1. It's a medium of exchange. We accept coins and currency in return for goods and services.

          2. It's a standard of value. We can use it to determine the value of a good or service.  For example, a computer selling at $2500 has a value 2 1/2 times what one selling at $1000 would have.

          3. It's a store of value. We can save our money and spend it for something we want in the future.

It's number three especially that the Federal Reserve seems  to concern itself with the most. For if inflation (rising prices) gets out of control, then money loses its store of value. If you put $1000 into a savings account at your local bank at 5% annual interest, you will have earned $50 at the end of the year, and your savings account  now shows a total of $1050. But if the rate of inflation was 10% during that same time period, then your savings account would buy about $945 ($1050 minus $105) worth of what it could have purchased a year ago.  In effect, the money you saved actually lost value. You would have been better off spending it, rather than saving it, on the day you put it in the bank. Of course, millions of others would realize the same thing, which would tend to increase the spiral of inflation even more. That's why it's necessary for governments and financial institutions to keep tight control of inflation. Otherwise, we might just as well use our paper money as wallpaper.

Is all money of equal value? No. You may accept my quarter for the sucker because we're both Americans. But what happens if you're Dutch? Will you accept my quarter then? Possibly not. What would I do then to get the sucker? I would have to exchange the quarter for Dutch coins that you would accept. But I may be in for a surprise because I would soon learn that my quarter is not precisely equal to your Dutch coin. We both accept money as a medium of exchange; we just don't accept the same money. In the Netherlands I would have to convert my dollars to your guilders.

Imagine, for example, that  my family and I want to go to the Netherlands, and that we take $500 along in spending money.  We arrive in the Netherlands and go to a Dutch bank.  The cashier takes the money and in exchange gives us 1,045 guilders, since $1 in American money is equal to 2.09 Dutch guilders (as of July 21, 1999).  Now we are on our way.  In other words,  they converted American dollars to Dutch guilders.  My mother decides to give me 50 guilders, which is $23.92 in American money, to buy anything I want.  I buy a watch for 20 guilders, which is $9.57 in American money. I have 30 guilders left, $14.35 in American money.  What do I do?  I get a two-piece bathing suit with the rest of the money, and we still have 995 guilders ($476+) remaining.  Now you know how to convert American dollars to foreign units of exchange.

*Conversions are accurate as of  July 21, 1999.  Currency values tend to fluctuate almost on a daily basis. Visit the Universal Currency Converter to calculate your own conversions.  It has many more countries than the seven listed above.

Commercial banks send worn-out  notes to a Federal Reserve Bank to be replaced. Then, the Reserve Banks sort the money they get and decide whether or not it can be reused. If it can be, they put it in vaults until it recirculates again through the commercial banks. Reserve Banks then burn the unusable paper money and return the damaged coins to the U.S. Treasury.