Money and Finance: Crash Course Economics #11

Summary

This Crash Course Economics episode delves into the world of money and finance, explaining the concept of money as a medium of exchange, store of value, and unit of account. It explores the evolution of money from barter to digital currencies like Bitcoin, and discusses the importance of the financial system in connecting lenders and borrowers through banks, bonds, and the stock market. The episode highlights the role of confidence in the value of money and the benefits of a diversified financial system in spreading risk and facilitating economic growth.

Takeaways

• 💰 Economics is not solely about money but more about trading and the principles behind it.
• 🔄 The barter system, while still in use in some contexts, is less efficient than using money for transactions.
• 💵 Money serves as a medium of exchange, a store of value, and a unit of account, facilitating trade and saving.
• 🏦 Money is not just cash and coins; it can be anything that is accepted as a medium of exchange, including digital forms like Bitcoin.
• 🌐 The concept of money has evolved over time, and today includes various forms, such as electronic money and virtual currencies.
• 💳 The financial system connects lenders, who want to grow their money, with borrowers, who need funds for various purposes.
• 🏢 Banks, bond markets, and the stock market are all part of the financial system that facilitates lending and borrowing.
• 📈 Stocks represent ownership in a company and can be profitable if the company does well, but they also carry the risk of loss.
• 📊 The stock market's fluctuations are not always a reliable indicator of economic health; they can be influenced by many factors.
• 🏦 Banks act as financial intermediaries, taking deposits and making loans, helping to spread risk and provide access to capital.
• 🔑 The value of money is based on confidence; it is valuable because people believe it to be so, not necessarily because of a physical backing like gold.

Q & A

What is the main purpose of money according to economists?

Money serves three main purposes: it acts as a medium of exchange, a store of value, and a unit of account.

Why is a barter system considered less efficient than using money?

The barter system is less efficient because it requires finding someone who has what you want and wants what you have, which takes time and energy. Money, on the other hand, is a universally accepted medium of exchange, making transactions quicker and easier.

How has the concept of money evolved over time?

Money has evolved from physical items like coins, cigarettes, and even mackerel in prisons, to digital forms like electronic deposits and cryptocurrencies like Bitcoin.

What is Bitcoin, and why do some people consider it money?

Bitcoin is a virtual currency that is not issued or regulated by any specific country. It is considered money by some economists because it is accepted as a medium of exchange by some people.

Why did the U.S. move off the gold standard, and what was the reaction?

The U.S. moved off the gold standard in the 1930s to have more flexibility in issuing money. Some people were concerned about not having tangible assets to back money, but many economists agree that money's value is based on confidence, not physical backing.

What are the two main groups involved in the financial system, and how do they interact?

The two main groups in the financial system are lenders (who want to save money for future use) and borrowers (who need money now and will repay it later). They interact through institutions like banks, bond markets, and stock markets.

How do banks function in the financial system?

Banks take deposits from lenders and loan that money to borrowers. The interest paid by borrowers is used to cover the bank's costs, with the remaining amount passed on to the depositors.

What is the difference between bonds and stocks?

Bonds are debt instruments where borrowers agree to pay back the loan with interest, while stocks are equity instruments where investors own a part of the company and may profit if the company does well.

Why do financial markets and instruments like stocks and bonds exist?

Financial markets allow borrowers to raise capital from many investors and spread the risk around. They also give lenders the ability to diversify their savings, reducing the risk of losing everything if a single borrower defaults.

How does the stock market differ from banks and bonds in terms of risk?

The stock market deals with equity, meaning that returns depend on the company's profitability, and shareholders may lose their investment if the company fails. In contrast, banks and bonds deal with debt, where repayment is typically guaranteed, making them less risky.

Outlines

00:00

💰 Introduction to Money and Finance

The script begins with Adriene and Jacob introducing the topic of money and finance in the context of economics. They clarify that while economics is not solely about money, it is fundamentally about trade. They humorously illustrate the inefficiency of the barter system and explain the advantages of using money as a medium of exchange, a store of value, and a unit of account. The hosts also discuss the evolution of what is considered 'money,' ranging from historical examples like cattle and shells to modern forms like digital currencies and Bitcoin, emphasizing the importance of acceptance and confidence in any form of money.

05:03

🏦 Understanding the Financial System

This paragraph delves into the financial system, highlighting the roles of lenders and borrowers and how they interact within this system. Lenders seek to grow their capital, while borrowers need funds for various purposes, such as purchasing assets or investing in business ventures. The financial system facilitates this interaction through banks, the bond market, and the stock market. Banks act as intermediaries, lending depositor's money to borrowers and sharing the interest received. The bond market involves the sale of bonds, which are essentially loans to governments or corporations, and the stock market allows businesses to raise capital by selling ownership shares. The risks and rewards associated with debt (banks and bonds) and equity (stocks) are also explained, with the latter being subject to the performance of the company.

10:04

🌐 The Role of Financial Markets and Institutions

The final paragraph discusses the necessity and functionality of the financial system. It contrasts the idea of direct lending between individuals with the benefits of using a financial system, which includes risk diversification and access to a broader pool of potential borrowers. Financial markets enable borrowers to raise funds from multiple investors, spreading the risk, while banks pool small deposits to make larger loans. The paragraph emphasizes that the financial system is relevant to everyone at some point, as most people are both lenders and borrowers. It concludes with a call to understand the importance of lending and borrowing in our lives.

Keywords

💡Barter System

The barter system is an ancient method of exchange where goods and services are traded directly without the use of money. In the video, it’s described as inefficient and time-consuming because it requires a double coincidence of wants—both parties must have what the other desires. The example given involves a dentist needing to find auto workers who need dental work, which illustrates the difficulties of the barter system.

💡Medium of Exchange

A medium of exchange is an item that is widely accepted as payment for goods and services. In the video, money is highlighted as a medium of exchange, making transactions easier than bartering. This concept is central to understanding why money is more efficient than direct trade and how it allows for easier and broader economic interaction.

💡Store of Value

A store of value is an asset that can be saved, retrieved, and exchanged in the future without deteriorating in value. The video contrasts money with perishable goods like fruit, explaining that money retains its value over time, unlike items that can spoil. This function of money is essential for saving and future purchases.

💡Unit of Account

A unit of account is a standardized measurement of value used to price goods and services. The video explains that money serves as a unit of account, allowing people to compare the value of different items easily. Without this, it would be difficult to measure the relative worth of various goods, like cars and bananas.

💡Digital Money

Digital money refers to currency that exists in electronic form, typically within banking systems or digital wallets. The video discusses how much of today’s money is digital, existing on computers rather than in physical form. It emphasizes the convenience and security of digital transactions, provided the system remains functional.

💡Bitcoin

Bitcoin is a type of virtual currency that operates without a central bank and allows for peer-to-peer transactions. The video mentions Bitcoin as an example of digital money that isn't tied to any specific country or bank, making it appealing for anonymous transactions. However, its use as a speculative asset limits its role as a regular medium of exchange.

💡Gold Standard

The gold standard was a monetary system where a country's currency or paper money had a value directly linked to gold. The video describes how the U.S. dollar was once redeemable for gold, but the system was abandoned in the 1930s. The shift away from the gold standard reflects the concept that money’s value is based on public confidence, not just a physical backing.

💡Financial System

The financial system is a network of institutions, markets, and instruments that facilitate the exchange of funds between lenders and borrowers. The video explains how this system allows households and businesses to invest, borrow, and save money more effectively than direct lending. It highlights the roles of banks, bond markets, and stock markets within this system.

💡Bond Market

The bond market is a financial market where participants can issue new debt or buy and sell debt securities, typically in the form of bonds. The video describes bonds as IOUs issued by governments or corporations to raise capital. Bonds represent debt, with the borrower agreeing to pay interest and repay the principal at a later date.

💡Stock Market

The stock market is a marketplace where shares of publicly traded companies are bought and sold. The video explains how companies can raise funds by selling stock, giving investors ownership stakes in exchange. Profits from the company are shared with shareholders, but unlike bonds, stock returns are not guaranteed and can vary based on the company’s performance.

Highlights

Economics is fundamentally about trading things you have for things you want, not just about money.

The barter system is inefficient compared to using money for transactions.

Money serves as a medium of exchange, store of value, and unit of account.

Traditionally, money has been cash and coins issued by governments, but it can be anything that is widely accepted for trade.

In prisons, items like cigarettes, postage stamps, and mackerel have been used as makeshift currency.

Historically, various commodities like cattle, grain, and shells have served as forms of money.

The Yap Island's 'rai stones', large limestone disks, were used as a form of money.

Modern money includes both physical cash and coins, and digital forms like bank deposits and Bitcoin.

Bitcoin is a virtual currency not regulated by any country, used for transactions and speculation.

The value of money is based on confidence in its acceptance and use within an economy.

The gold standard, where money was backed by gold reserves, is no longer used by any country.

The financial system connects lenders, who want to grow their money, with borrowers, who need capital now.

Banks, bond markets, and the stock market are three ways lenders and borrowers interact within the financial system.

Bonds are debt instruments where the borrower promises to pay back with interest, while stocks represent equity in a company.

The stock market's fluctuations are not always reliable indicators of economic health, but reflect changes in economic fundamentals.

Financial markets allow for the spreading of risk among many investors, rather than relying on a single investment.

Understanding the financial system and the roles of lending and borrowing is crucial for individuals at various life stages.

Crash Course Economics is supported by Patreon, allowing the content to remain free and accessible to everyone.

Transcripts

Adriene: Welcome to Crash Course: Economics. I'm Adriene Hill.

Jacob: And I'm Jacob Clifford. And today we're going to talk about money and finance.

Adriene: I know we said in the first episode that economics isn't really about money...

Jacob: Economics isn't about getting rich quick, but it all boils down to trading things you have for the things you want.

Adriene: Like, I've got this giant zucchini, but I'd love that piece of pizza. Want to trade?

Jacob: No way!

[Theme Music]

Imagine you live in a world without money, and you're a dentist that wants to go buy a car.

First you need to find a bunch of auto workers who need dental work.

And if these workers don't want dental services and prefer being paid in something else like

flat-screen TV's, then you have to find TV manufacturers that have toothaches.

Try posting that on Craigslist...

This is called the "barter system", and it takes a lot of time and energy.

Of course, many people still barter for stuff, but for most transactions, we use money.

Which is a way more efficient way to do business.

The people who really need dental care will pay you with money, which you can now use to buy a car.

Economists point out that money serves three main purposes.

First, it acts as a "medium of exchange". It's generally accepted for payment for goods and services.

Now, that medium of exchange means we're not stuck in the barter system.

Next, money can be used as a "store of value".

The reason why a dentist doesn't normally accept fruit or baked goods is because you can't save those things up to go buy things like cars.

Plus, bananas go bad pretty quickly in a safe deposit box.

Money also serves as a "unit of account".

We don't measure the value of cars in bananas, muffins, or root canals.

Instead, we use money because it's a standardized metric that allows us to measure the relative value of things.

Adriene: Most people assume that money is just cash and coins, issued and endorsed by a government.

Coins have been used for thousands of years, and they're a great example of money,

but technically money is anything that's used as a medium of exchange.

For example, cigarettes were used as money in prisons until smoking bans were put in place.

Nowadays, prisoners use postage stamps and even small packages of mackerel as currency.

Animals like cattle and sheep, also sacks of grain, all these have been used as money.

Some societies even used feathers or shells.

The indigenous people on Yap Island in the Pacific Ocean used money called "rai stones".

These were large doughnut-shaped disks made out of limestone.

The largest ones are around ten feet wide, and weigh four tons.

The point is what economists consider money is anything that's accepted as a medium of exchange.

And that's changed a lot over time.

Today, cash and coins are often used as money since they're easy to carry around, physically durable, and hard to counterfeit.

But a lot of money today doesn't end up in anyone's pocket, or wallet, or duffel bags, or even wheelbarrows.

It moves around electronically.

Increasingly, people get paid in the form of checks or direct deposits into their bank.

A lot of our money isn't physical. It's digital. It exists on some bank's computer.

And as long as that computer is secure, and the zombie apocalypse doesn't permanently knock out the power,

and your nation's monetary system is functioning as it should, those electronic dollars do all the things they're supposed to do.

Another form of digital money that you often hear about is Bitcoin. Bitcoin is a virtual currency that is not issued or regulated by a specific country.

But since some people accept it as payment, many economists consider it money.

Unlike other electronic currency, Bitcoin doesn't involve a bank, so people can, in theory, buy things more anonymously.

This appeals to people who don't trust central banks, and also people who want to buy illegal stuff online.

That illegal trade means law enforcement and regulators are also very interested in Bitcoin.

Bitcoin isn't only for internet drug deals though.

There's a lot of speculation in Bitcoin, meaning people buy up Bitcoins, hoping to turn a profit on them.

This makes Bitcoin more of a speculative asset, and limits its use in buying and selling actual goods and services.

Could Bitcoin or another virtual currency be how everyone pays for things in the future?

Who knows! But if anyone wants to give me 10 Bitcoin for this zucchini, we've got a deal.

Jacob: There's kind of a glaring question here: what makes these pieces of paper so valuable?

Well, in the past, each dollar issued by the U.S. government was redeemable for a specific amount of gold.

That was called the "gold standard", and it meant that the government couldn't issue more money than it had in gold reserves.

Back in the 1930's, the U.S. decided to move off the gold standard and some people freaked out about not having something tangible to back our money.

But it's important to remember that money, whether it's cash, or gold, or small pouches of mackerel, is all about confidence.

The Nobel Prize winning economist Milton Friedman said, "The pieces of green paper have value because everyone thinks they have value."

With that in mind, a gold standard, or even a mackerel standard,

might not make money more valuable or reliable.

A lot of economists agree with this, which is why no country uses the gold standard.

There are calls by some politicians to bring it back, but that's probably never gonna happen. Sorry, Ron Paul.

Adriene: Okay, I know we said economics is not about the stock market.

But now it's time to explain what it is, and why it's important.

The stock market is just one piece of something much bigger: the financial system.

To understand the financial system, you need to picture two different groups.

First, you have "lenders". Sometimes these are corporations with a bunch of cash, but lenders can also be ordinary households, people like you and me.

Us regular folks are gonna need money in the future to retire, or send our kids to college, or go on a vacation to Yap Island.

So we need a way to turn the money we have now into more money in the future.

The second group is "borrowers". There are several different kinds of borrowers.

First you have other households who want to borrow money to buy stuff like a car or a house.

You also have businesses that have a great idea for a new product, but that have a problem.

They need money to make the product, and they'll have money when the finished products are sold.

But for now, they need to borrow money to invest in capital - things like machinery, tools, and factories.

And they'll pay it back once they make some sales. Basically they need to buy stuff to produce other stuff.

Third, you have governments who need to to borrow money because they're spending more than they're bringing in.

So you have lenders who have money now and want to turn it into more money in the future.

And you have borrowers who need money now and will repay it in the future.

The financial system is a network of institutions, markets, and contracts that brings these

two groups together. Lenders put money into the financial system, which loans it out to borrowers.

These borrowers pay back those loans with interest, which makes it worth the lender's time. Let's go to the Thought Bubble.

There are three ways this exchange takes place. The first is banks.

A lender deposits money in a bank, and then the bank turns around and loans that money

to a family who wants to buy a house or a business that wants to expand.

As those borrowers pay the interest on their loans, the bank takes part of that money to cover their costs and passes the rest along to the depositor.

The second way lenders an borrowers link up is through the "bond market".

A government or large corporation that needs to borrow money will sell bonds to lenders.

A bond is basically an IOU in which the borrower agrees to pay regular interest payments and promises to repay all of the money back at a set date in the future.

If that lender decides they'd rather have cash now, they're free to sell that bond to another party.

The third way lenders and borrowers link up is through - you guessed it - the stock market.

Say Jacob and I want to expand our lemonade business, but we don't have the money to do it.

We could sell stock, which is basically slices of ownership in the company.

Households get the stock, and we get the cash.

If our company profits in the future, and we become lemonade moguls, we'll share some of

those profits with the shareholders, or the shareholders can sell the stock at a higher price.

Either way, they make money if the company's profitable. Thanks, Thought Bubble!

So banks and bonds have something in common. They're dealing in something called "debt".

If you get a loan from a bank, or if you're a government that sells a bond, the amount you must repay is set.

In almost all cases, you're obligated to pay back the amount you borrowed with a set amount of interest.

Stocks, on the other hand, are known as equity.

If a company enjoys high profits, shareholders get more money.

If a company goes bankrupt, shareholders may get nothing.

In the news, you'll hear about changes in the Dow Jones Industrial Average.

But fluctuations in stock markets are not reliable indicators of how the economy's doing.

Often changes in the stock market are reactions to real, or just perceived,

changes in economic fundamentals like consumer confidence, the unemployment rate, and GDP growth.

Bonds and stocks also have something in common. They're traded on markets for financial instruments.

Bonds are debt instruments, and stocks are equity instruments, but they're both pieces of paper that are traded on markets with many buyers and sellers.

Banks, on the other hand, are financial institutions. With the help of the FDIC, they safeguard our money while making loans to individual households and businesses.

Jacob: So why do we even need this complicated financial system? Why don't households take their savings and lend them out directly?

Well, if you want to loan out your life savings to your neighbor so he can launch his artisanal smart phone business, go for it!

But that's a pretty risky bet, so you're more likely to use a financial system.

Financial markets, with instruments like stocks and bonds, allow borrowers to crowd source the money they need to borrow.

They raise their capital from lots of investors and spread the risk around. Banks do the same thing.

They accumulate small deposits from thousands of people and use that to make loans.

It's like Kickstarter except better because you get money as opposed to an earnest thank you email.

From the lender's point of view, a financial system allows you to spread your savings over dozens or hundreds of different loans.

A few companies might go bankrupt and a few people might pay back their car loans, but those losses will be offset by borrowers who do pay back their loans.

You don't have to put all your eggs in one basket.

Adriene: So that's money in the financial system. The thing to remember here is that this stuff is not just an abstraction or someone else's concern.

Almost all of us are lenders and borrowers at some point in our lives, and understanding lending and borrowing is a big deal.

While it might seem like you're borrowing from a faceless institution,

you might be borrowing my money from that faceless institution, and I'm gonna need that back if I can't get anyone to accept this zucchini as payment.

Thanks for watching!

Jacob: Crash Course Economics was made with the help of all these nice people who believe in some way that there's value in those green pieces of paper.

Your green piece of paper can help support Crash Course on Patreon. You can help keep Crash Course free for everyone, forever. And you get good rewards.

Thanks for watching! DFTBA!