People work for money. People kill for money. People steal for the money. People give it away in charity. Money is the root of all evil. Money is the solution to all problems. But what is money really?
What is Money?
Money, specifically USD (like Euro and other major currencies of the world), is something called Fiat money. This basically means that it’s a piece of paper issued by the government. It’s not backed by any physical commodity. It’s not backed by gold, silver, oil, or anything else. The only reason USD is money because the US government has decided to call it so. Period.
Where Does Money Come From?
Because USD is Fiat money, meaning it doesn’t have to be backed by any real commodity, Central Bank or Federal Reserve (Fed for short) can simply print money into existence. Really. They simply print it. Just like that!
What Gives Money Its Value?
The value of money is determined by supply and demand. Just like anything else.
Let’s say you can buy a goat for $20 (Don’t judge me. I have never bought a goat). If the government sends a check of $100 to everyone, the amount of money available in the economy will increase. More people will be able to buy a goat which will increase the demand for goats. As a result, the goat seller may increase the price of a goat to say $25. This is called inflation where the value of money reduces.
Similarly, if the government took away $100 from everyone (say by tax hike), there will be less money available in the economy. Fewer people will be able to buy a goat which will reduce the demand for goats. As a result, the goat seller may have to reduce the price of a goat to $15. This is called deflation where the value of money increases.
The value of money is determined by what can be bought in exchange for it. Digits printed on the currency are immaterial.
Who Controls Money Supply?
Fed controls the supply of money in the economy by setting interest rates for borrowing money from banks. Fed lowers interest rates if they want to increase the money supply. Fed increases interest rates if they want to reduce the money supply.
What Creates Demand For Money?
Demand for money is created by goods and services produced in an economy. Greater the number of products competing for your money, higher is the demand for money. For example, Apple created a demand for money by producing the iPhone. People needed money to buy an iPhone, but their income was the same. This resulted in an increase in demand for money while supply stayed the same.
Why We Pay Taxes?
“..in this world nothing can be said to be certain, except death and taxes..”
– Benjamin Franklin.
If the Fed can simply print money, why does the government collect taxes from us? While this is a complicated question, let me give you my two favorite reasons:
1. The government steers our spending behavior through taxes. If the government wants us to spend less on something, they hike tax on that spending. If the government wants us to spend more on something, they give tax breaks for that spending.
Real Estate is a classic example. There is a severe shortage of affordable housing in the US. The government doesn’t want to build houses. They encourage us to do the job for them by giving huge tax breaks for investments in Real Estate.
2. USD works as money only because we all have agreed to use it as a medium of transaction. The government makes sure that we continue to depend on USD by insisting that we pay taxes, and we pay it in USD. That’s why Bitcoin may never be able to displace USD because we will always need USD to pay our taxes.
P.S. High-paid professionals are always wondering where to invest their savings. They don’t want to take more risks with stocks because they already have a lot of money invested in the stock market. Not knowing where to invest, they end up with lazy money sitting in a bank.
At Wealthy Together we help high-paid professionals grow wealth by teaching Passive Real Estate Investing. Sign up for FREE E-Mail Education Series and make more money with less risk.