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What Determines Value of Money?

Okay, let’s be real, how this piece of paper with the founding father portrait can get you a Lambo and Ferrari? To add more confusion, It is also a 100% guarantee that if you tried to buy Ferrari with your own poorly drawing founding fathers on a piece of paper…, you’ll end up kicked by the dealer’s security and no cars to ride.. Trust me it is a prophecy. Hmm, that still makes sense tho, but in this digital era, How can numbers on your bank account and phones still be valuable? Is it can be used to buy your new Ferrari? How this is possible? Is this ‘magic’ piece of paper has that much value in it? Again, What determines the value of money?

As you may know, that ‘magic’ piece of paper is called money. It is one type of currencies that people used in daily trade activities. What makes currencies special is they made our ancestors’ life easier. Instead of bartering which takes so many times to conduct, they only have to use currencies to pay some amount of goods or services. It is a wide form of payment and exchange method that people accepted across the world.

Back in 1000 B.C people in Ancient Greece still used metal coins such as gold or silver as their currencies. But, around 700 B.C Chinese people found that using paper-based currencies was more flexible to meet greater demand of currencies as its industry sectors grow and also because it was easier to create. These two stories give us a question… How can these two different things serve the same function as so-called currencies? I can accept it for coins, well sometimes it was made from pure gold or silver that has its own (intrinsic) value. I mean people really appreciate gold or silver at that time (some people worship it too). The amount of value your coin has will be the same as the value of the metal that made it whether it’s gold, silver, or copper.

And now, how about paper-based currencies? We all know it’s only a piece of paper… So isn’t it worthless? But still, people used it as currencies and traded it for goods and services back then in China. Well, this kind of currency is called fiat money, or simply just money in general. Even though fiat money doesn’t hold value on intrinsic terms, they are still considered valuable and several factors could explain the value of this ‘magic’ paper.

It is all about money scarcity…

For starters, like goods and services value of money is determined by its demand and supply. By this, I mean the availability of money itself. Across the globe, money has been printed by the governments through the central banks. So central banks have the power to determines the value of money by deciding how much money they should prints. If they want a higher value in money they can cut their money production so it becomes scarce now. But if they overprint it the money will become worthless then.

Okay if you’re not clear enough here is some weird analogy. Have you ever wonder why the price of medical masks was soaring when the first time pandemic hit? It is because many peoples want to buy masks but the supply has dwindled, so it was scarce back then and people are willing to pay a bunch of money to acquire them. But what if suddenly there were a medical mask rain overnight? You can get it for free in front of your house. Puff…. and medical masks were worthless only in one night. Well, this idea is the same as money, when there was too much money in an economy it will lose its value.

According to our ‘fun’ scenario, this implies that the government cannot prints money and gave it to people for free. If this happened, then the money will be worth less than before and this is what we called inflation. The idea of currencies and money is we can trade them for certain goods or services so it’s a must-have value on it. When money is worthless, it will be more expensive to acquire certain goods than before. Suppose with hundred bucks today you can have let say fifty cotton candy, but five years later when the amount of money is more than today, maybe you can only have thirty cotton candy or less with the same hundred bucks. This can happen because your money loses its value as its amount increases over time.

.. And also all about faith!

Well, there is another factor that made money has value other than its boring supply and demand side. To has ‘value’ people across the universe must agree and believe that this piece of paper called money is valuable. But why do we need to agree on it? First of all, every money printed by the government is legal and official as currencies. That is why you cannot create your own currencies because people won’t accept it as a form of payment, or simply people won’t believe it has value on it.

So theoretically, you can create your own currency named after yourself, but you need to assure people around the world that your currency really has value on it. Unfortunately, it is not an easy job to do. Country’s currencies such as US Dollars, Euro, or Japanese Yen rely on its government and economic indicator to determines the value of their currencies. Countries with better economic performance and higher demand for their currencies will have higher value and thus make them more expensive than other currencies. Also, everyone believes it has value because it is printed officially by the corresponding government. But how about your own currency? Do people believe it is has value on it?

Let’s wrap it up, peeps…

To sum up, the value of money itself isn’t that magical as we first think is. It’s not because of the portrait of our founding fathers that gives it values but its supply and demand and our faith in it as an exchange method across the world. When people lose faith let say in US Dollar because of recessions, we will see that their value will be decreased and inflation will follow after that.

This also applies to the balance in your bank account on your phone, whether the money was physical or even digital it is not affected the value of money itself. The value of money itself will depend on availability and people’s faith in it. Well, a certain amount of money can have the same value as one Ferrari then, after all the true purpose of money is as a universal exchange method.