What is money?
Have you ever seen a coin that is made of totally blank, unmarked metal? All coins start like this, but at some point most get stamped or marked by a king, an emperor or a nation. Once stamped, these metal disks are suddenly transformed into money.
What’s going on here? The value of metal coins has little to do with the value of the metal in the coin itself—notoriously, it costs around two pennies to make a penny in the United States.¹ But by stamping a number on it, the government can decide exactly how much it is worth. This system, where money is valuable just because the government says it is, is called fiat money. Today our money isn’t something inherently useful—like gold, salt or cigarettes. While these types of currencies consisting of items that are useful in themselves, called commodity money, have been used in the past, today almost all our money is something that would otherwise be useless.
We give money value by agreeing to use it and treat it as valuable. Otherwise, it’d just be metal, paper, and numbers on a page. As long as everyone plays along, money is accepted to be valuable, and can be used regularly to buy and sell things. That’s why a 100 dollar bill can be said to be worth 100 dollars; because we all believe the fine print that says it is. This means the value of fiat money comes primarily from the trust we have in the institutions issuing and upholding it. When that trust breaks down, the consequences can be dramatic, as money quickly loses its value—this (pretty scary) process is called hyperinflation.
But coins and paper bills are only one form of money, called currency. When you think about how much money you have, you probably also count the savings you have deposited in the bank. If you have them, you might even count financial assets you own like stocks or bonds.
How do we draw lines around what counts as money and what doesn’t? As you can imagine, this is a tricky question, and economists have come up with multiple definitions of money that include different things. This becomes pretty important when trying to understand how money is created because physical currency makes up a surprisingly small amount of the total money supply.