Why Money Exists

Start at the bakery

Imagine a small community with a fisher, a baker, a miller, and a doctor. You are the fisher. After a morning on the water, you want to trade a fish for bread.

The baker likes fish, but she already has enough. She needs flour. You both have something useful, yet you cannot make this trade. You do not have what she needs right now.

You could look for someone who has flour and wants your fish. Then you could take that flour to the baker. But the search takes time, and your fish will not stay fresh forever.

Trading goods or services directly is called barter. The hard part in this example is finding the right match: someone who wants what you have and has what you want.

Now imagine that everyone in the community accepts the same money. You sell your fish to someone who wants it. Then you take the money to the baker and buy bread.

Why does the baker accept the money? She expects to use it to buy flour from the miller. She does not need to want your fish for you to buy her bread.

Money lets you sell to one person and buy from another. The two trades can also happen at different times. This made-up community shows a problem money can solve. It does not mean that every society first used barter and then invented money in this way.

More time to become good at something

Now think about the doctor. One patient needs treatment, but has only potatoes to offer. Another can repair a roof. The doctor may need neither of those things today.

If every patient had to bring exactly what the doctor wanted, arranging payment could take a lot of time. With accepted money, the doctor can treat a patient and buy food or repairs later.

The farmer can spend more time farming. The baker can spend more time baking. Each person can focus on a skill and trade with others for the rest. That is specialization.

Money helps these people work together. The money itself does not grow wheat, bake bread, or teach the doctor. People still need knowledge, time, tools, and materials to do those jobs.

Three jobs money does

First, money helps you pay. You hand the baker something she can spend later. The name for this job is medium of exchange.

Second, money helps you compare prices. Imagine a loaf costs 10 units and a bag of flour costs 20. Both prices use the same unit, so you can see that the flour costs twice as much. You do not have to turn each price into fish first. This job is called unit of account.

Third, money helps you save for later. You can keep part of today’s payment for next week. This job is called store of value.

Saving the money does not guarantee what it will buy. If prices rise, the same number of units buys less. Money can do all three jobs while doing some of them better than others.

A payment can change a record

Let’s return to the bakery. This time you pay from a bank account. In our made-up example, you and the baker use the same bank. You have 40 units in your account. The baker has 10.

You approve a payment of 10. There is no fee and no borrowing in this example. The bank subtracts 10 from your balance: 40 − 10 = 30. It adds 10 to the baker’s balance: 10 + 10 = 20.

Before the payment, the two accounts held 50 units in total. After the payment, they still hold 50: your 30 plus the baker’s 20. The money has moved between the two records.

A ledger is a record of balances and payments. The bank has changed its ledger. No physical coins had to pass between you and the baker.

The bank must also check that you allowed the payment. A stranger should not be able to take 10 from your account just because the numbers add up. Enough money and permission to spend it are two separate checks.