However, it is inconvenient to talk about objects in terms of their labor content or units of labor they save the buyer; and since most objects are exchanged with one another rather than with labor itself, money becomes a more convenient measure of value. This is the reason goods (and services) are quoted in money prices; but we must not forget that the true value of goods is measured in labor. You exchange the produce of your labor with the produce of others' labor. You get paid for your labor in money, and you exchange that money with the goods produced by other people's labor, is the real exchange going on in the world. Labor is the true price of all objects; money is their nominal price only.
There are two main uses of money; 1) As a facilitator for buying and selling of goods and services by being a unit to measure their value, e.g. 1 kg of potatoes for 1 Euro, and 2) As a measure of someone's worth, e.g. Maria is worth a million dollars. The use of the same term money to denote these two has caused substantial confusion for humanity, as covered by Adam Smith. However, the primary use of money is the former-a unit of the measure of the value of goods and services.
When considered as a measure of value of goods and services, money may be thought of as similar to the unit of mass, the kilogram (kg) or the unit of length, the meter (m), which from the Système Internationale (SI) units conventions, are standardized units of measuring mass and length.
We must remember that the kilogram and the meter are not absolute measures. When you measure something with a weight scale, it is never a completely accurate reading-because of the calibration errors in the weight scale against the 1 kilogram international prototype in Paris, which is the standard unit of mass in the SI convention (i.e. when you buy 1 kg of something, it is never really 1 kg). This error, the difference between the mass and the actual mass if you had the prototype in your hands, is tolerated depending on your applications-if you are measuring something ultra-sensitive, you need a very accurate and calibrated scale; whereas for most goods, an error of let's say 1% is acceptable (the 1 kg of oranges you weighed are really 990 g if the oranges were weighed by the Paris prototype, but you can live with this error.). Furthermore, the prototype of mass in Paris is itself a variable (recent attempts to put them in terms of physical constants notwithstanding) and susceptible to drift over time-what it was a hundred years ago is not what it is today, because of corrosion, loss from use and wear and tear, etc. The point is-that even for a physical unit like the kilogram, there is no absolute measure, but we carry on our lives quite well despite the uncertainties and errors.
However imperfect it may be, money (a dollar or a yuan, for example) is a measure of value just like the kilogram for the mass. Different observers will give a different value for mass, length, etc. for an object depending on the accuracy of the tools they have, or how much experience they have with similar objects; the same is true for value, wherein an object can be assigned different values by different observers.
Value may be considered to be a fundamental property of all objects just like the mass or the length, and we can say:
Object properties: Mass (kg), Length (m), Value (dollars, yuans, etc.), and other properties.
The most common use of money is to measure the value of objects. I came up with a global currency based on this idea of money. It is called the Smith Unit, details here.
Role of the banks and financial systemI have come across a lot of confusion in investment and financial circles on the meaning of money and the role of the banking and financial system.
The primary role of the banking system, who are dealers in money (they buy and sell money, which includes loans in money with interest rates) is to aid the fundamental exchange of goods (and services) with each other. The banking system, supervised by a central bank like the US Federal Reserve, serves as an intermediary between the exchange of goods- for goods normally are exchanged for money, and then that money is used to buy other goods.
The banking system serves the role of a marketplace enabler like eBay or Alibaba is assisting transactions-but does not decide or has any role to play in deciding the value of the objects. Buyers and sellers assign money value to the objects, and eBay assists in promoting a smooth transaction between these parties. eBay can also give out loans to the buyers and charge them an interest for that; but that does not mean that eBay is deciding the value of the objects or the interest rate. The buyer is the ultimate decision maker because she has the right to not buy the object at the first place, because she may not like the price of the object or may not like the interest rate which eBay wants to charge (if she wants to borrow from eBay to pay the seller).
eBay could also come up with its own currency, and call it an eBay unit or "points" as is done by some gaming companies. You could use these points to buy objects on eBay. There's nothing sacred about currencies and money, and once you agree on a system of exchange like using eBay points to buy things on eBay, you can carry on your life perfectly well (after all, you can buy pretty much anything on eBay). How would you get these points to buy objects from eBay? You could assign 20 points for every US dollar, for example, and that would then aid you in converting all your existing monies into eBay points. An eBay point would be worth US $0.05 in that sense, but would be variable with other currencies (tracking the variation of the US dollar with other currencies). Once you have your eBay account with 10,000 points, no matter what currencies you used to get those points in the first place, all that matters to you is the prices of objects on eBay in these points and how you can use these 10,000 points to buy these objects. The points take a life of their own, and are the only things which matter for buy/sell transactions on eBay.
What if eBay decides to give points to people for free-or loan points to people who are likely to default (i.e. not give the points back)? Well the whole system depends on eBay being pragmatic in its handing of points, and not doing this. Otherwise the marketplace collapses, and eBay itself goes bankrupt. Therefore, it is in eBay's self-interest to not give away free points, or to give loan in points very carefully, only to people who are unlikely to default. The maximum point loans which eBay can loan out without it itself going bankrupt is limited by the total assets held by eBay.
Understanding the banking and financial system becomes much easier if you realize that they are like the operators of eBay who facilitates transactions but do not decide the value of the transactions or the terms of payment, including the interest rate. More on the role of banks here.
From gold and silver to paper money, and now to electronic moneyPaper money had started becoming popular in the times of Adam Smith (around 1750). However, banks were still required to hold reserves in gold and silver, and the paper currency was backed by gold. This would later be formalized in 1944 by the Bretton Woods agreement, where all currencies were required to be backed by reserves in gold, and someone could exchange their currency for gold by going to a bank at any time.
The Bretton Woods system came to an abrupt end in 1971, when the US, the main original creator of the Bretton Woods agreement, opted out of the convertibility of the US dollar to gold. This was credited to President Nixon, and many economists and finance types predicted the end of the world and run away inflation after this was instituted.
None of the crazy things predicted by the economists happened after 1971. The US continued to become a richer country, and fiat currencies became the norm after that time.
How could this be? How could a country (US) or the world, transition to a completely paper based currency system, and still have no major catastrophes? A paper currency bill guarantees nothing except that you can exchange it with another one of the same denomination at the bank, now that the gold backing was removed.
This successful transition happened because prices are a time series, and people work hard at an individual level to provide price stability, and in reality exert a constant downward pressure on prices (the inflation data and story is a big lie). When millions of Americans (and the same thing happens in other countries) go out to buy stuff in the grocery store today, they use the prices of yesterday (or whenever they went to the grocery store last) as an anchor, because their wages have not jumped up suddenly in 24 hours. They naturally try to get the most amount of goods for the X dollars they want to spend in the grocery store today. If prices of a product jumps up suddenly, they will buy a much smaller volume of that product, or in many cases will not buy that product at all. This behavior, coupled with the thousands of products which they can spend their money on, forces the prices of goods to fall constantly. This in effect means that dollars saved are worth more tomorrow than today, because they will buy more goods tomorrow that today, even if you just hold the dollar bills and get no interest.
The faith in the dollar bill is a faith in the US government, because the government runs all its accounts in that currency, and collects taxes in dollars. This is why the people could accept a freely floating currency- they realized that as long as the US government runs its accounts in dollars, their money will always have good value, for the government would not manipulate an instrument it uses itself for its operations (this lesson unfortunately is not followed everywhere, which is why Venezuela's currency has no value). With the removal of the gold backing, the banking system became less relevant.
This general stability of money value is also the reason that in most countries countries, people will buy a house on a 20 or 30 year mortgage. They know that prices of goods are generally stable, and so are their jobs. If they were not sure of the general stability (or downward movement) of the prices of goods or their wages (if they lose their job, they can find another job in a few months) they would never enter into such an onerous contract as buying a house on mortgage. They also have some liquid savings in paper dollars (or the country's currency), which can cover the monthly mortgage payment in case they can't earn anything for some months. All this shows an inherent stability in the system-and there was no need for them to rush to a bank to turn their dollars into gold. This happened BEFORE the gold standard was removed; the banks were rarely being called for converting their dollars into gold in the US even before 1971. The paper currency took a value of its own, and with a stable government and a reasonably responsible banking system backed by a central bank (which doesn't give money out to people for free) which in turn is backed by the US government, the system in the US and all countries successfully transitioned to freely floating currencies without any backing of gold.
Together with this there was a very important development-the invention and acceptance of checkbooks (checks are an extension of paperless bank-to-bank transfers, where previously you had to go to a bank to transfer money from your account to another account. You could now do it much more easily by issuing checks). Checkbooks are a predecessor to electronic money-they removed the necessity of carrying around wallets and suitcases (if you buy expensive objects) full of dollar bills. Once checkbooks became an acceptable form of payment, the banks needed to print even less dollar bills, because many payments, especially the larger ones (e.g. buying a car, a house, or company-company payments), could be made via checks.
Credit and debit cards took out checkbooks from the equation. As I write this (in 2017) a large amount of purchases are done by credit and debit cards. We can safely say that in many countries, and this includes not just the wealthy and developed countries, but even developing countries like India and Chile, that most transactions are electronic; via bank-to-bank transfers, checks, debit cards and credit cards. I would guess that more than 95% of the total value of the transactions in any developing or developed country are non-cash, i .e. electronic (Sweden reports that only 2% of the country's transactions are using paper money). We don't carry around large amounts of paper currencies in most countries; and it is safe to say that we have now moved from paper money to electronic money in the 21st century. The advent of the Internet which simplifies bank-to-bank transfers and payment wallets like Paypal and Venmo are all aiding in a complete elimination of paper currencies, and I surmise that in a couple of decades they will cease to exist altogether, with all money being completely electronic. Sweden already has committed to a completely electronic money system from 2020 onwards.