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What, exactly, is money?

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Q: In plain and simple English can you explain exactly what is money?  I know it is green and made from paper or coins.  However, I need to understand what IS money.  How is it created? And if the gold standard was eliminated, then is our paper money backed only by the faith in our government and their power to manipulate us and the world?   What stops another country from creating a faith-based currency? Nuclear capability?   It all sounds like a house of cards. And if that were true, then would it be most likely that we would associate value to tangibles, such as real estate, gold, tulips?  Once the gold standard was eliminated, did we also eliminate REAL money? — Carmen A., Garland, Texas

A: We’d hate to be the cashier at the supermarket who had to break a $20 for you.

But you’re right that much of the strength of a country’s currency lies in the faith we all have that it will retain its purchasing power. While coins may have intrinsic value based on the metal used to mint them, paper money is essentially a legal document. What you're really asking is: what are the terms associated with U.S. paper currency?

Here's what the Federal Reserve has to say:

"According to the Legal Tender Statute (section 5103 of title 31 of the U.S. Code), United States coins and currency (including Federal Reserve notes and circulating notes of Federal Reserve banks and national banks) are legal tender for all debts, public charges, taxes, and dues. This means that all U.S. money, as identified above, when tendered to a creditor legally satisfies a debt to the extent of the amount (face value) tendered....However, no federal law mandates that a person or an organization must accept currency or coins as payment for goods or services not yet provided."

In other words, if you owe someone money, the law says you can use these paper notes to pay them back — and they can't try to take your house to settle the debt. But if someone is selling, say, food or gasoline, they are not required to take your paper if they don't want to. They may prefer that you pay them in live chickens or lumber — based on amounts negotiated by buyer and seller.

That kind of barter economy, of course, worked for thousands of years and still prevails in developing countries with currencies that no one has faith in. Using paper to stand in for physical goods first became widespread in the Western world about 500 years ago, when European trading companies financed voyages to find and transport precious goods like gold, spices, lumber, etc. In some cases, those "notes" could be redeemed for goods. Some notes changed hands — with the value rising or falling based on news of the voyages success or failure.

This exchange of paper was the origin of the modern global financial markets, where traders swap billions of dollars worth of stocks, bonds, cattle futures, etc. In some cases, people trade paper than represents the value of another piece of paper called "derivatives." And every time you write a check, you're creating new paper — with separate legal terms and conditions. (There are limits on your obligation to make good on that paper. For example, if someone puts a gun to your head and tells you to write a check, that's called armed robbery.)

You're correct that if the world suddenly and completely lost faith in the value of the U.S. dollar, our economy would pretty much grind to a halt. That's one reason U.S. currency was recently redesigned — to thwart counterfeiting. Nothing undercuts confidence more than the fear that the paper you're working for and saving is not the real thing.

Today, we've moved beyond paper. Economic value is now represented by electronic bits stored in the sprawling computer networks that make up the U.S. "financial system."  It's taken decades for banks to create the current widespread consumer confidence in credit cards, ATMs and electronic funds transfer. In some cases, you're out of luck if you don't have access to plastic. (Ask any teenage kid trying to buy something on the Internet.)

This electronic system is clearly subject to abuse, as anyone who has been the victim of identity theft can attest. But as long as the folks at Wal-Mart will let us use plastic, we'll keep shopping there. The minute they stop accepting it, many consumers will likely move to the next merchant.

It's possible to envision nightmare scenarios: terrorists figure out how to hack the U.S. financial system or flood the world with bogus dollars. But we'll always need to trade and, in the modern world that means creating something — paper or bits — to represent the value of our labor and accumulated wealth.