What Gives Money Its Value?
Over time, for something to be considered "good" money, it had to serve three distinct purposes. These functions evolved naturally as societies sought more efficient ways to trade and store wealth.
Medium of Exchange
It's something everyone widely accepts as payment for goods and services. You use it to buy coffee; the coffee shop owner uses it to pay their suppliers.
Store of Value
It must be able to be saved and retrieved later, and still be valuable. It holds its purchasing power over time (though inflation can affect this).
Unit of Account
It provides a common measure of value. Instead of saying a car is worth 20,000 bananas, we say it's worth $20,000. It's a universal yardstick.
These three functions are interconnected and build on each other.
Early societies faced the 'coincidence of wants' problem. If you had an apple and needed a chicken, you had to find someone with a chicken who wanted an apple. This was inefficient. Shiny, rare items like shells or metals became early forms of money because they were durable, portable, and everyone agreed they had value.
Around minute 1 into the video you saw that someting changed. In 1971, the U.S. government severed the link between the dollar and gold. Money was no longer backed by a physical asset. This decision effectively turned all major world currencies into 'fiat' money—currency that has value because the government declares it does. It's backed by trust in the government, not by a physical commodity. This gave central banks the power to print money without the constraint of gold reserves.
Over time, societies discovered that certain materials, like gold and silver, were particularly well-suited to serve as money. They were not only durable and portable but also divisible and, most importantly, scarce. This scarcity gave them a stable value. However, the story didn't end there. As economies grew, the systems built around these precious metals also evolved, leading to new opportunities and new challenges.
A store of value is an asset that can be saved, retrieved, and exchanged at a later time, and be predictably useful when retrieved.
Here's a lecture from MIT OpenCourseWare to explain the Supply and Demand, it's 40 minutes but that is the key to understand the value concept and value under scarcity better for future sections.
If you've watched the supply and demand lecture, you now know that the value of money is determined by how much of it is in circulation. But who decides this? The following video explains how institutions like the U.S. Federal Reserve aim to balance the value of the dollar to manage the economy.
Around minute 1 into the video you saw that someting changed. In 1971, the U.S. government severed the link between the dollar and gold. Money was no longer backed by a physical asset. This decision effectively turned all major world currencies into 'fiat' money—currency that has value because the government declares it does. It's backed by trust in the government, not by a physical commodity. This gave central banks the power to print money without the constraint of gold reserves.
A unit of account provides a universal yardstick for value, making it easy to price goods and services. But the fiat currency system that allows printing money indefinetely without needing an anchor point caused the unit of account is not always same everywhere or not even same at the same place.
Here's a mini metaphorical cartoon to shortly explain the inflation, if you have watched the MIT courseware on suply and demand you may pass as well.
And now knowing what inflation is and how it effects the value of money thus the unit of account you can watch the following video: