Modern schooling institutions ensure their students know what year the War of 1812 happened or how to do 50 long division problems by hand in under 30 minutes. However, most pupils graduate from formal education with hardly any knowledge on one of the most fundamental, important aspects of daily existence: money and economics. Financial and economic illiteracy among educated people today comes at a great cost to them and to human civilization.
Without an accurate understanding of something you use every day that will affect your life greatly, how can you make the best financial decisions? Without the basics of economics, how can you have the best possible life? Here are some crucial facts that everyone should know about economics.
1. What is Money?
What is money? Go ahead, try to define it in your own words. Is it pieces of paper people use to pay each other? The definition and power of money as a technology is underappreciated in a world driven by and obsessed with money. Some loud-mouthed, short-sighted know-it-alls with a comfortable salary who’ve never run a business say we should abolish money. They say that this would solve many of the world’s problems.
They have no idea what they’re asking for or what they’re talking about, though. These so-called experts know almost nothing about what they’re talking about. But money is three simple things:
A durable store of value.
A medium of exchange.
A unit of account.
Three Problems Money Solves
Here’s how money has always solved these three problems from early civilization as people tried to make their lives better:
If you produce more than you consume, there’s no benefit if you can’t save it for when you need it later. But what if you could trade them to someone who has something more durable? It could be a gold coin or a bottle of whiskey, which was a currency traders used in 18th century Kentucky. Then, during a bad year, you can trade that gold coin or whiskey for some extra food from someone who’s having a good year.
Trading makes the world a better place. So long as a trade is voluntary by both sides with no coercion, both parties are wealthier after then exchange than before it. They make the trade because they would rather have what they are trading than what they have. The problem with trading is what you have may not be right for whatever someone else has at the time. So money makes it much easier to trade.
As a precise unit of account, money allows for the precision of measurement and accounting. When it comes to production and trade, money enables people to create vast sums of wealth. It has also driven the explosion of the modern industrial economy. Without this unit of accounting, it would be impossible to make big decisions with any degree of certainty or real understanding.
2. What is Paper Money?
When money first emerged in early civilization, it met the three criteria of storing, exchanging, and measuring productive value. But it had to be durable, portable, and something people could divide into small, interchangeable units. Gold, silver, and other precious metals were ways to create money. They were rare and durable, as well as easily divisible and transportable. People have traded different currencies such as glass beads, sea shells and whiskey.
However, each of them had certain limitations, making them less ideal than precious metals people could transform into denominational coins. Next, modern banks starting writing people notes representing the precious metal reserves they physically had in a vault under the bank’s protection. People began exchanging these notes as money. Dishonest banks realized they could write up these bank notes even without the metal reserves to back them up. Some even lent their notes out at interest for a profit.
Today this dishonest lending is a standard, institutionalized practice and feature of the global economy. The world reserve currency, the U.S. dollar, is a paper currency the Federal Reserve Bank issues with no actual commodities to back it up. Every time the Federal Reserve Bank creates more dollars and lends them out through smaller banks, which it does every day, it makes our dollars worth less.
The process in the last section results in a constant devaluing of the money supply, or inflation. Over time, money becomes worth less, so you need more to exchange for the same goods. For example, what you could buy with $100 dollars 50 years ago, you can’t buy with $100 today. This is an important thing to understand about money because if you don’t grow your wealth somehow, it shrinks.
Or more accurately, the rest of the money supply will grows, even though your wealth doesn’t. This leaves your money less valuable than it was before. For example, you make a low risk, low reward investment that offers the safety and assurance of not losing your money. However, it only pays out one percent in returns. This means it will be outpaced by the growth of the money supply.
And if inflation averages three percent every year, your money can’t give you one percent in returns in your safe investment vehicle. In fact, you will lose two percent every year to inflation. Because of inflation, you aren’t using your money to be productive. Instead, it is just evaporating in slow motion.
Also, if you trade your time and labor for money, and never have enough to invest, the news is even worse for you. If historical trends from the last hundred years are any indication, you could lose over 75 percent of your hard-earned savings through inflation. Your best protection against inflation is to go from an employee to starting your own business. If you are successful in business, make smart investments to protect and grow your wealth.
4. What is Economics?
Here’s another question for you: What is economics? Try to define it clearly and accurately in your own words. In short, the word, “economics,” comes from the Greek word for managing your household. So it refers to the study of the choices people make given that they have limited resources and unlimited desires.
The central question of economics is how people deal with the problem of scarcity. The two main answers divided the entire world into opposing camps for nearly a hundred years. And they nearly destroyed each other and the entire planet over it. Here’s why:
Communists believe a command and control economy is the best response to the problem of scarcity. A few people constituting an intelligent and benevolent authority should tell the rest how to use scarce resources. And finally, everyone has to go along with whatever the authorities decide.
Capitalists believe a market economy is the best response to the problem of scarcity. More people should be involved in making small decisions for their own best interests. They also must be responsible for themselves and whatever amount of wealth they have. Also, price signals in the market would automatically coordinate their decisions to help them achieve the best results.
5. The Law of Supply and Demand
The Law of Supply and Demand comes from the Law of Supply, and the Law of Demand. Here’s how it works:
The Law of Supply: This rule says the greater the price of a good, the more suppliers are willing to sell. And the lower the price of a good, the less suppliers are willing to sell.
The Law of Demand: This is the other side of the same coin. It says the greater the price of a good, the less customers are willing to buy. And the lower the price of a good, the more customers are willing to buy.
For example, if that big screen television costs too much, it may be nice, but customers won’t want to buy it. But if it’s on sale for a low, bargain price, that same customer may buy two of them.
Also, the Law of Supply and Demand states the more there is of something people want, the lower its price will be. And the less there is of something that people want, the higher its price will be.
This is common sense. For example, someone might spend over a thousand dollars on a big cut diamond because they are quite rare. But if they you could find a big cut diamond as easily as pebbles on the ground, no one would spend a thousand dollars or even a dollar on one.
6. Prices Act as Signals
Price systems that emerge from the simple, intuitive laws of supply and demand are the greatest marvels of the universe. The price system signals information of a market economy as the world’s largest, most important computer. Prices signal the allocation of resources and the decisions people make every day.
Anything people value in limited supply will have a high price. And this high price signals the economy to get more people involved in solving the problem of that good’s scarcity. It also rewards people for doing that.
As soon as people solve that problem and that valuable good is more available and easy to obtain, prices drop. This is because there is no more value in trying to make that good more available. The price system incentivises profit seekers to move on to other problems to solve. Price signals offer rewards for solving these new problems of scarcity.
7. Employment Rate
The frequently discussed metric in the macroeconomics of a nation’s economic health is the employment rate. And this figure’s ups and downs are the focus of much media coverage and journalistic analysis, too. But in truth, the employment rate is a terrible metric for gauging the health of an economy. This is for a couple of reasons:
People determine the rates of employment and underemployment in different ways. They use various methodologies and definitions, so it’s difficult to know what the number means or if it’s trustworthy.
But more fundamentally, employment rates are not a measure of productivity. To illustrate, the president of any country could automatically make the employment rate 100 percent overnight. All they would have to do is sign a bill drafting every adult into the military. Then they just offer them a paycheck. It could be a simple as paying half dig holes, and half to fill those holes back in and employment goes up.
So then, workforce participation would be at 100 percent and unemployment would be zero. But there is no new value was in the process. And in fact, this would destroy much of the value due to the opportunity costs of people doing unproductive work. So, whether or not someone has a job is not a measure of their productivity.
These seven crucial facts everyone should know about economics should help you make better money decisions. Understanding the economy and how money works is something everyone should be able to do. The rules behind economics are simple, yet they can help you grow your finances.