How Does Money Work?

Phil Ebiner
A free video tutorial from Phil Ebiner
Top-Rated Instructor, 2 Million+ Students
4.5 instructor rating • 128 courses • 2,013,268 students

Lecture description

In this lecture of the Personal Finance Masterclass, you'll learn how money works. To truly understand the rest of this course, you first have to know how money works. Let’s go back to the basics.

  • An alternative to a currency-based society, is a bartering economy. This can get tricky and wouldn’t work if the two parties don’t agree on what to barter.
  • That’s where money comes into play. Transactions happen quicker and people can ‘barter’ with people who wouldn’t have normally wanted their offers.
  • Today money comes in many forms - paper notes, coins, digital numbers.
  • For many many years we were on a gold standard, meaning each paper note or coin was worth a specific amount of gold. From 1879 to 1930s people could trade $20.67 for an ounce of gold.
  • But during the Great Depression, FDR cut the dollar’s direct tie with gold to be able to pump more money into the economy.
  • In 1971, Nixon further cut ties with gold because rich foreigners were exchanging dollars for gold and depleting the U.S. gold reserves.
  • Today, our money has worth because people have ‘faith’ that other parties will accept it. This is called ‘fiat’ currency. Kind of scary, right?
  • Depending on the supply and demand of a particular country's currency, it has stronger and weaker worth.
  • Printing money is a way to help a country in times of trouble, but this increase inflation - meaning the money is worth less. For example, with more money out in the world, it is worth less. This is why countries try to maintain inflation.
  • Before we get too deep, the basic premise is that money has value that can be exchanged for goods and services. It’s harder to understand this value when it’s just a number on a computer screen.

Learn more from the full course

Personal Finance Masterclass - Easy Guide to Better Finances

Your complete personal finance guide to understanding finances. Save more, invest smarter, reduce loans, retire earlier!

07:09:20 of on-demand video • Updated January 2018

  • You'll be the master of your own finances.
  • You'll know how to create a smart budget that helps you increase savings and reduce expenses.
  • You'll increase your income with a promotion, new job, side hustle, and online income.
  • You'll have a step-by-step process for reducing your loan and/or credit card debt.
  • You'll know the process for buying a house and saving up for a down payment.
  • You'll know how retirement works, how to save and invest for retirement, and how much you'll need to save and invest for a worry-free retirement.
  • You'll learn how to retire early and achieve financial freedom!
English [Auto] In a world where money is represented by a number that you see when you log onto your bank account online or on your phone we tend to lose track and lose the value of how much that money is actually worth. And so to really understand and prepare yourself for the rest of this class we have to understand how money works. So if you go back in time before there was actually currency or money where you have dollar bills credit cards debit cards coins that's what currency is to buy things. There was actually a time where people bartered and so that is where you basically have something of value. I make bread and you want to receive something. I need to pay for that duck that I want to cook for dinner later on. And so as a bread maker I might trade my bread for some of that duck. The problem with the bartering system is if I make a lot of bread and people don't want that bread I don't have anything of value to give them to buy things. And if I really need that new door handle or that new pair of shoes or if we still barter today and I really wanted to buy that iPhone people wouldn't want a bunch of bread for that new item. So people invented currencies as a way to exchange goods. This new currency based economy works so much more smoother than the bartering economy. People can care around coins or dollar bills that have value that everyone sees has value and use them to buy things. One difference between now and back when currency was started and even through the most of the 9900 is something called the gold standard in the United States for a long time. Our money was actually backed by gold. Meaning that our dollar bill was actually worth a certain amount of gold. You could literally buy an ounce of gold with twenty dollars and sixty seven cents. The government only printed the same amount of money as there was gold in their reserves. But during the Great Depression FDR cut the dollar in direct tie with gold to be able to pump more money into the economy. In 1971 President Richard Nixon further cut this tie between gold and U.S. dollars because rich foreigners were exchanging dollars for gold and depleting the U.S. gold reserves. This creates inflation because the more dollars that are out there the less they're actually worth. You can imagine say we live in a world with ten total dollars. Every dollar is worth a lot. One tenth of the entire economy basically. But then the government comes in and prints 10 more dollars so in this total economy we have $20. What that means is that every dollar is worth half as much as it was previously. That's where we get inflation. And while the government uses printing money to help out the economy they have to do so carefully and sometimes they even take out money from the system to reduce how much inflation there is. So after we cut ties with the gold standard we became what's known as a fiat currency. Fiat money is currency that a government has declared to be legal tender but is not backed by a physical commodity. So we have to literally trust the system that while our money isn't backed by gold we can't go into the bank anymore and get an ounce of gold for 20 bucks. We have to trust that our money is worth something. And that's kind of scary. We're basically basically basing all of our worth. The tens of thousands of dollars that we're saving up we're spending. We're in debt off of faith before we get too deep in this discussion of what money is and having faith in our system. I just want to leave you with the note that you have to understand that our money is worth something. It's not just ones and zeros on your computer screen. If we were actually exchanging dollar bills and coins for the things that we are buying we would probably buy less. So with the credit cards with the modern age of transferring money here and they're getting paid while it's so convenient it also makes us lose recognition of the value that money truly has. And if we don't recognize that value of money of the dollar bill the one dollar bill we're going to struggle financially hopefully enjoy this set up for the rest of the class and we'll see you in the next.