The following is a quick look at the purpose and function of money in general. The more specific purposes that it has for us as individuals will be looked at on another page.
The first half of the question has relatively simple answer. The purpose of money – the reason it was invented or developed – is to facilitate the exchange of values between people. Barter, the basic trading of things and services, is a very limited and cumbersome method of exchange. The chair you just built might be worth 100 tomatoes, so how do you trade it to get just one or two for dinner?
These basic problems with barter have been looked at many times before. But what is perhaps even less understood is how important money is to the growth of wealth. Wealth is not money, after all, but the things which actually enrich our lives, such as indoor plumbing, cars, books and restaurants. Barter is so limited, in fact, that most technological innovations are almost unthinkable without the development of some kind of currency system. Could we have a computer if we didn’t have money? This is where we get into the function of money.
How Money Works
Consider for a moment how difficult it would be to make a car if there was no money. In order to build a large factory to produce automobiles, you would have to either enslave people or first have something to trade for their labor (yes, all agreeing to cooperate is possible, but unlikely). There is no efficient way to borrow wealth when currencies don’t exist, so you would have to gather together food, wood, or whatever people wanted in order to trade that for their help. You might get together with others and pool your resources, but any way you look at this, it could take years just to create the building for the factory.
Tires, plastic knobs, tools? Assuming these things existed in a world without money, how do you trade for them? And if you could ever get a car built, how would you trade them for what you want? Put customers on the eighty-five tomatoes, four pounds of cheese and fifteen chickens per month plan? It is clear that money makes much more wealth creation possible, and though we can argue about what has value, if we can agree that medical care, enough food for health and a roof over our heads are all good things, then we can see the importance of money.
Money is not just a means of exchange, though. It is also a store of value for the individual, family or even society. Trade a house for 25,000 pounds of food and you have to worry about spoilage destroying much of what you gain. But with money safely tucked away in the bank from the sale of a house, you can hold onto your wealth and spend it as necessary for whatever needs the future brings.
In it’s simplest form, money could be, and was at times, coin or pieces of paper that represented real things. Gold, for example, has been used as the “backing” for many currencies. But it could be something as simple as a pieces of paper that promised the holders a pound of corn for each one turned it into farmer John. The farmer could have stored some corn and created the paper and then those bills might circulate all over for years before many are traded in for the corn. Carrying fifty bills is much easier than carrying around fifty pounds of corn to trade.
As long as those things that back money are valued, and as long as there is a means to trade the paper bills for those things, money will be accepted by others in exchange for almost anything. But we currently have “fiat currencies” in most nations, meaning money that has no commodities or other valuables directly backing it. It is often said that it only has value because of the trust of the people. However, this isn’t entirely true. Since you have to pay your property taxes and all of your debts with money, you have to get some.
That demand makes money worth something. With trillions in contracts all denominated in dollars, for example, there has to be demand for dollars. And as long as too many are not printed, the value is maintained by that demand despite the lack of physical commodities backing the currency.
Fulfilling Purpose and Function
Money is meant to facilitate trade and that’s meant to serve both sides of the trade – otherwise why would they participate? So the ultimate purpose of money is to make life better. If it doesn’t do that, it is being used incorrectly. That can be true on an individual level or for a whole society.
The function of money meanwhile, requires some faith in its value. If a government destroys that by printing too much money it interferes with or destroys the proper functioning. If it determines what prices are paid for things, instead of that being decides by participants in any exchange (the market), it also interferes with the function of money. This ultimately has a negative impact on the purpose – the bettering of life.