How Money Works

Money. How does that word make you feel? Is it a rush of adrenaline? Dollar signs running through your head like a slot machine? Perhaps you feel motivated, ready to send those work emails you’ve been putting off or spend an extra hour writing that movie script that you’re certain will be a hit.

But maybe you don’t feel so good when you hear that word. Maybe the mere mention of money causes your hands to go clammy, your heart rate to rise, and your brain to start doing somersaults around all the ways in which you don’t have, need more, or want more money. Whatever your response is, we all have one, because as they say, money makes the world go round.

Whether it’s your five dollar coffee every morning to start your day or the three thousand dollar loan payment you just made, not a day goes by for most of us that we don’t consume, spend, study, or merely think about money. You could be the driver of a sports car wearing a diamond necklace or the homeless person who watches that car drive by. On one level or another, money matters to us all.

Yet, for as much as money matters, it’s surprising that there’s so much we don’t know about it and a lot of things that we think we do that are just plain wrong. This is a crash course on how your world and the world of high finances intertwine in hopes that in the end, we know that much more about this illusion that keeps the economic world spinning.

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Now, back to our story. Contrary to what you might think, money as we know it today, at least in its physical form, has remained largely unchanged for millennia. The first sign of what we might think of as a banknote took the form of a piece of leather in China in 118 BCE. And 900 years later, paper currency came to fruition.

It would be another several hundred years before this kind of currency would make its way to Europe and then the rest of the world. Centuries have now passed, yet the basic concepts invented by the Chinese aren’t that distinguishable from what we have today. In fact, the only real difference is what these notes and coins represent.

The first real global system of value and currency was the gold standard, which began in England in the early 1800s. It tied a currency’s value directly to the established value of gold. So in a country like the United States, one dollar was pegged at exactly one fiftieth of an ounce of gold. This system was set up in such a way that ideally it would provide a stable monetary environment around the world, and it did for a while.

But as with all natural resources, the supply of gold was not as fixed as we originally thought. As a result, countries began dropping it as a means to measure the value of their money. In 1971, U.S. President Richard Nixon officially severed the convertibility between dollars and gold: "I have directed Secretary Conley to suspend temporarily the convertibility of the dollar into gold or other reserve assets."

By that time, the U.S. dollar was seen as the global standard currency. So once the dollar was no longer dictated by the value of gold, pretty much nothing else was. If the value of the dollar is no longer determined by the value of gold, what exactly makes one dollar worth one dollar?

Well, instead of a commodity-backed system like the gold standard, we now have something called fiat currency, which has no intrinsic value and is instead backed by a government. What gives today's dollar its value is the economic supply and demand in the United States, and who controls that? Governmental financial systems.

In the case of the United States, it has the Treasury and the U.S. Mint in charge of printing its money. But as we can see in the growing number of digital businesses and iPads in place of cash registers, money printing is a dying business. So if a government isn’t literally printing money, how exactly does cash come into circulation?

The vast majority of money exists only as numbers on a computer—incredible amounts of money digitally credited to commercial banks by a country’s central bank. This central bank controls how much money it deposits into the commercial banks based on the economic situation of the country. During the earlier stages of the pandemic in the U.S., some of that money was sent directly to bank accounts in the form of stimulus checks, but that’s an extreme case.

In most of the time, that’s not how the money ends up with us. Here’s how it usually works: A central bank sends money to banks and credit unions nationwide, and they in turn distribute that money into the economy by lending it to their customers.

This brings us to the topic of debt. Around 80 percent of Americans are in some kind of debt, yet many people don’t know what exactly debt is and how its moving parts work. What they do know, and what is backed by several studies, is that even the idea of paying off debt can be a severe emotional strain. No one wants to owe anyone anything, but with the cost of living vastly outpacing the money we earn for a living, loans are the necessity everyone hates yet most can't live without.

You get a loan to purchase your car, start your small business, go to college, or buy a house. Very few people can afford a house with the money in their bank accounts, yet all of us need a roof over our heads. So some people choose to rent while others decide to take out a loan from the bank in the form of a mortgage.

The banks aren’t charity organizations; they’re built to make a profit. And the way they do that is through interest. Interest is the amount you, the borrower, pay to use the money a bank or financial institution has loaned you. Think of it like the rent you pay on your apartment every month. You don’t own the apartment, but you get to use it for a fee. In the same way, you don’t own the money you use to purchase your house, but you get to use it for a fee.

This by-now, pay-later model does not only exist for big purchases like a house and college; it has permeated our entire society so much that most things we purchase now exist on this model, especially since the creation of the credit card. Don’t have enough cash for that new couch? Put it on your credit card! Want to get that new iPhone? Pay a monthly fee to your internet service provider! Heck, even consoles like the Xbox follow the same model.

We now use credit to pay for even small things like a sandwich, a new pair of pants, or food for our dogs. If we pay our balances on time for those purchases, we can avoid the interest rates that credit card companies charge, and we’ll be fine. But for a lot of us, especially in hard times, we tend to build interest on our cards, which can quickly lead to a pretty bad spot financially.

Credit cards can help provide a financial buffer in a bind if needed, but they also come with an element of risk. So, are they worth it? There’s some mixed feelings about this. Some people think that using credit cards is a surefire way to send yourself straight into sinking debt, but others see frequent credit card use as a way to build good credit, which, if you’ve ever leased an apartment or bought a car, is an important part of daily life these days.

Whichever side of the fence you’re on, one thing we can all agree on is that you need to be careful when using credit cards so that you don’t overspend and dig yourself into much deeper debt than is necessary. By being wise with your credit, savings, and increasing your income, you can have enough disposable income to finally do with your money what every financially stable person suggests: invest.

Investing basically means committing your money to something to earn a financial return. It’s making your money work for you. One mantra in the investing world is: the greater the risk, the greater the reward. Investments like bonds are safer but offer lower returns, while investing in individual stocks can provide incredibly high returns but are also extremely risky.

And let’s not even get started on cryptocurrency! We’ll need an entire video to go over investing properly, but in the end, if we get the opportunity to do so, our goal is to build our wealth—to increase how much we’re worth. That’s the entire point of money: to show how much something or someone is worth.

How much is a carefree retirement to you? That will inform how much money you put away in your retirement account. What about a car? We might splurge on a luxury vehicle because it’s worth it to us to enjoy the extra comfort and social status.

The byproduct of this is that as a society, we become obsessed with the idea of worth—from material goods and worldly possessions to personal worth and even that of others. Publications like Forbes and Bloomberg publish wealthy individuals' net worths, assigning a number to someone’s success. To create these lists, dozens of reporters track down millionaires and billionaires all across the world, collect their personal information, add up all of their presumed assets, and subtract their liabilities.

So if Jeff Bezos owns approximately 10 percent of Amazon and we subtract his jet, his yacht, and any other creature comforts that he enjoys from that 10 percent, we should be able to identify his net worth. That simple addition and subtraction seem deceptively easy, doesn’t it? That’s because it is. It’s hard to get reliable data, and it’s hard to figure out exactly where wealthy people store their money.

Of the wealthiest people in the world, many are investment bankers. But on a day-to-day basis, there’s no way to know the composition of their firms' portfolios, which directly dictates the wealth of those who run it. There are also discrepancies when it comes to celebrities' wealth—perhaps where most of our obsession lies.

Kylie Jenner was said to be the youngest self-made billionaire at one point, but her business isn’t just valuable because of how much money it makes; it’s valuable because she is involved with it. The business's worth is reliant on her involvement; her wealth is wrapped up in her business and vice versa. So, the equation becomes even more complicated.

I hate to break it to you, but most celebrities' net worths are basically guesses and not really an accurate portrayal of how much they control. So why are we glued to these lists? Are we ultimately comparing ourselves to the world’s richest people, allowing ourselves to be fascinated by financial wealth at our own expense?

The truth is, while learning about money and understanding how our economic system works will not guarantee you a spot on Forbes' billionaire list, it can give you peace of mind. Knowing a thing or two about money can help us see the world a little more clearly and not feel so overwhelmed by economic news. Because although having money isn’t everything, not having it is.