What is money, really?

Imagine you bake excellent bread and you need a haircut. The hairdresser does not want bread today — she wants her bicycle repaired. Now you need a bike mechanic who wants bread, and a hairdresser who… You can see where this is going. Money exists to cut through exactly this tangle.

Swapping things directly gets messy fast

Swapping goods or services without money is called barter. It works when two people each want what the other has, at the same moment. Economists call this lucky match a double coincidence of wants, and it is rare.

Barter has a second, hidden problem: too many prices. If a village trades only 3 goods, it needs 3 exchange rates (bread–eggs, bread–wood, eggs–wood). The number grows much faster than the number of goods.

So people settled on one thing that everybody accepts. You sell your bread to anyone for that thing, then use it to pay anyone else.

The four jobs of money

Anything that does these jobs well is money, whatever it is made of:

1. Medium of exchange — people accept it as payment.
2. Unit of account — prices and accounts are written in it (“€2.40”).
3. Store of value — it still buys roughly as much next month as today.
4. Standard of deferred payment — loans, rents and wages for the future are written in it.

These jobs can come apart. When a currency loses value quickly, people often keep paying with it but start saving and pricing in another currency. Many people in the former Yugoslavia remember shops pricing goods in Deutsche Marks in the early 1990s, while change was still given in dinars.

What makes good money?

Over thousands of years, people tried shells, salt, cattle, metal and paper. The things that worked best shared six properties:

Gold and silver scored well on almost every line, which is why metal coins dominated for about 2,500 years. Today, most money is not a physical thing at all: it is numbers in bank accounts that everyone trusts. That trust is the subject of the next lessons.