How do societies initially trust using money when it has no inherent value?
In: Economics
It’s an interesting long story that you can watch on youtube [here](https://www.youtube.com/playlist?list=PLmKXQuG1OdOyGI0ZyjgiqMQW9r03Fs60k) if you have time
But basically it all started with: “i owe you 5 gold so here’s a paper that says ‘i owe you 5 gold’ signed by me, now you can go to a bank and ask the Banker to give you 5 gold from my account”
But what happens if you give that piece of paper to a third person? You basically create a paper money
I think you’re asking about what’s called “fiat currency”. This currency is NOT “not backed by anything”. It is backed by debt; that means, somebody ultimately owes the money to the bank that issued it. You see, money is not just airdropped out of helicopters; for an euro to start its existence, somebody must borrow it from a bank.
This man (let’s call him Jim) then buys off you a cup of lemonade with this money. Why do you put your trust into that, and exchange your work for it? Why do you believe that, when time comes, Jim will make you a cup of lemonade in exchange for getting the money back? He could just sit there and say “meh, keep your money, I ain’t getting my hands dirty and making any lemonade for you”, and you go home thirsty, and wondering if it was such a good idea to put your trust into the money and having exchanged YOUR work for it in the first place.
Well, the thing is, Jim OWES money to a bank. And if he does not pay up, the bank will do anything to shake the money out of him, and seize his collateral (when you borrow money, you have to give something in return, like mortgaging your house). Therein lies your assurance that when you will need to buy something with your money, Jim will be there and ready to perform, because he needs to repay his debts.
This is a simplified example, but this is in essence how fiat money works. Governments, corporations and people borrow it from banks, and the money is backed by their future performance and by the collateral that they post for their debts. So fiat currencies are not unbacked – they are backed by land plots, homes, buildings and promises of those who borrowed the money from banks in the first place.
How did we initially trust digital money? Same thing.
Its going to be a process that involves a lot of people saying “this is going to be so much better, you should use it”, and some people saying “HA! I fucking told you that paper money was stupid, now you lost all your money just because your house burned down!”
Etc.
Money’s value comes from one’s ability to trade without having any goods or services immediately available. It’s essentially an IOU, and everyone agrees to use it because it’s a lot easier than bringing the surplus of your vegetable garden to the supermarket every time you want to buy something.
As long as everyone has faith in the currency and goes about their day, everything is fine. That is, you assume your national government is a stable and reliable issuer and your currency will be worth about the same next week as it is today.
Pretty much every currency you might handle is based on the shared idea that it has value. Some percentage of total currency in use is backed up with holding of other foreign currency or precious metals, but it is not 100% and often not even 10%. Unlike say 100 years ago, any particular note you may have in your wallet or in your bank account does not entitle you to trade it in for a set weight of gold or silver (or a set number of Dollars/Euros/Yen). It is not a “Gold Certificate” or “Silver Certificate”, but a trade instrument based on faith and confidence in the particular currency issuer.
If a large enough group of people no longer feel that the currency is good or going to be good in the near future, there will be a large scale attempt to transfer their currency into a different country’s currency, move into precious metals, durable goods or otherwise abandon a particular currency and devaluation begins to occur. People worry that their national currency isn’t going to be worth anything next week, so they start selling it on the cheap this week in the hope of getting some value before the system becomes further devalued. If the national bank can’t check this in time and restore confidence/value, volatility can spread through the system and runaway inflation can occur, driving the value of any particular denomination of currency down dramatically. If many/most/all people feel a currency is unreliable due to high volatility, it essentially becomes worth nothing.
The US dollar was originally backed by gold. Meaning, anyone could turn bills in for gold coins, and turn gold coins in for bills. Bills were basically deposit slips for the giant government gold stockpile at Fort Knox.
So the answer (at least for the US dollar) is that it was “bootstrapped” using gold (going back hundreds of years to Spanish gold coins).
When there started to be a lot of technology in the late 1800’s / early 1900’s, this caused big economic problems.
Due to the new technology, the other stuff in the economy was growing faster than the supply of gold. (Think growing crops with tractors instead of horses, or all the increased efficiency due to railroads and factories and electricity.) Prices are “sticky” meaning they don’t adjust quickly, especially downwards. And when they do, it causes a bad economic crash where lots of businesses fail and lots of people lose their jobs.
So they changed the system. Overnight they outlawed the private possession of gold, and [changed business contracts](https://en.wikipedia.org/wiki/Gold_Clause_Cases) so that contracts based on gold were based on dollars instead.
Everyone was already set up to use dollars, so they kept using dollars. That’s what they call “network effect” — once it’s big enough, it’s self sustaining. (The sudden gold ban was a shock, and a lot of people were outraged at the government, but business kept on going, and the court system upheld the government’s actions.)
Also, it helps that the government does business in dollars. Most people need to pay taxes, so they need dollars for that.
On the other side of the equation, the government spends all the taxes it collects (and then borrows so it can spend even more). So if you want to sell your services to the government, you’ll be getting dollars for them. You could be an 18-year old Army private, a mid-level Washington bureaucrat, or a NASA scientist building space robots. If the government’s paying you, they’re paying you in dollars.
Trust is built up by being proven it can be trusted. The first paper money were paper certificates written up by rich merchants who owned big vaults that they rented out to others so others can store their gold for safe keeping.
Trust is also lost when that same currency proves untrustworthy. There have been many instances in history when currencies have lost their value because people lost their trust in it.
Trust is built up like any product. First, there’s the early adopters, then the followers, and last are the late adopters.
There are a lot of good answers here talking about the trust aspect of believing that the money will work after the initial transaction, but the biggest thing is that it’s just easier to use money than anything else.
Barter is annoying. At any moment, you’d need to justify the exchange of apples for chickens. But what if the guy yesterday traded shoes for chicken? Are shoes more valuable than apples? What about when the guy with the apples sold apples to another person for two bags of rice? Is my chicken worth two bags of rice? It’s too many exchange rates changing every day. Money is uniform.
But even more simply than that, money is easy to carry around. Only the real hardos would initially prefer lugging around sacks of grain to trade instead of lightweight sheets of paper or easy to carry coins. Since money was invented in small groups and not in big societies, it was relatively easy to make the change and have everyone agree on it.
You’re a builder. I’m a farmer.
It’s quite painful for me to give you 2 million eggs so that I can have a house.
I like to think of it as an evolution. Basically, the answer is because someone said so. Why do you take money? Your parents told you you could, and the people you interact with were told that too, so you can all use money now. Same thing with like gold for example. I can give you a block of gold and it doesn’t really serve you much more than a very fancy door stopper, but someone wants it so now it’s valuable.
But where did it start? Well a good place to go looking for that answer kind of starts way back when to the first banks. You hold my stuff, you give me a voucher for what I have. That’s a huge oversimplification, but that’s basically what it boils down to. Nowadays, they took money off the gold standard, but by now everyone pretty much accepted that paper money has a value.
But why does money have a value when it isn’t tied to anything? Because everyone thinks so. Money is just a concept, just a piece of paper. If you take a step back, money is just a commodity. At this point you are asking the question “why does anything have value?”. A potato can feed you for a day but it’s not worth much, while a painting on a wall is literally useless but can be worth millions.
Another reason is also, because the government says so. A lot of countries tie the value of their currency tied to the dollar. So they say “we will pay you 1 American dollar for however much of our dollar”. So, how does the American dollar work? Well, on every note you’ll notice it say “This note is legal tender for all debts, public and private.”. What that means that somewhere in the law it says that in any transaction, the receiving party has to accept that piece of paper as having a certain value, and accept it as payment. They don’t specify what “$1” is actually worth, but that’s really because things are valued in dollars, not the other way around. So one dude can sell a potato for $20. The law doesnt mean that you are forced to buy that $20 potato, but if you were buying that potato, that guy is supposed to accept a $20 as payment. Every country has similar laws, and every currency usually says similar things on their money.
So, asking the question “why does money have value” is really just as good as asking “why does anything at all have value”. It just does.
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