Lesson 1: Money & Banks

Written By Rohan Milak

Welcome to Equitable Investing! We congratulate you on your initiative to learn more about the exciting (I promise) world of economics, finance, and investing. Here, we will be discussing the concept of money and banking.

If you’re anything like me, you’ve probably had some disturbing thoughts regarding the concept of money. What is it? Where does it come from? What stops us from using Ben Franklin’s face as a place to write our grocery lists?

Let’s start from the beginning and get to the bottom of what money really is. Like everything we’ve learned in school, money starts with a brief history lesson. A long time ago, in the Kingdom of Lydia in 1000 BC, people used a bartering system to exchange goods and services. For example, if I have chicken and I want steak, I’ll trade some of my chicken for some of someone else’s steak (clearly I have gotten the better end of this barter).

But let’s bring this concept to the modern-day. If I want a subscription to a music streaming service like Apple Music, my chicken probably won’t do me much good. So as a society, we thought of a system that lets me get music without giving Tim Cook chicken. We all agree to make something else that is valuable to both Tim Cook and myself. That “thing” is money and we’re willing to trade our goods and services for it. This “money” is denoted by currency depending on your country - in the US we agreed on dollars to be the medium (aka the thing) of value, whereas Japan decided on “yen” and India decided on “rupees.”

Boom. That’s what money is.

Now where does it come from. Imagine for a moment that you give the cashier at your local cafe a $20 bill for an overpriced $9.50 latte. The $10.50 you get in rumpled cash and change may have come from a customer, who got it from their work, who got it from another business, and so on. If you trace the rumpled cash back enough and you get to the Treasury, an institution of the federal government whose job is to create, or mint all the dollar bills and coins in the US. It’s also their job to make sure there’s a stable amount of currency in the country, meaning they can’t print too much or too little (we will cover the concepts of inflation and interest in a later lesson).

Boom. Now you know where money comes from.

Let’s say the local cafe where you bought your latte actually has lots of people paying cash for their steeply priced beverages (we get it, lattes are trendy). After accumulating a sum of money, the cafe will eventually have to store their money in a bank. When the cafe (or any money earning entity like yourself) deposit money in the bank, you are customers in a business. Unlike our childhood understanding of banks, they do not have a compartment labeled with your name where the exact crumpled bills you deposit can be withdrawn at any time. Banks take your money and loan it out to other clients, who pay the bank interest in exchange for the loan. For instance, if Zach saves $100 at his local Bank of America, the bank may lend that money to Ben. Eventually, Ben repays the $100, with an added interest of $20. At the end of the day, the bank made a $20 profit.

At first glance, it might seem that Zach was short changed $20. Afterall, the bank used his money, right? For starters, banks exist to keep money safe; if you lose a mattress loaded with $100, it's gone; however, if a bank loses your $100, they still must pay you back (you might have heard “member FDIC” at the end of bank commercials). Secondly, banks will pay you interest for the right of holding your money, though it will be less than the interest charged to customers who take out a loan. To go back to that above example, while the bank makes $20 off Ben, they might pay Zach $2 of interest. Banks present a tough deal but we can’t live without them. Besides, who still uses the same pink piggy bank they were given at their 5th birthday party to store coins and small bills of cash… not me… obviously…

That’s all for today. Make sure to check out the next lesson on value and look into the topics of additional interest.

Topics of Additional Interest (from easiest to most difficult):

  • investment banks

  • fractional banking

  • quantitative easing

Sources:

Rohan Milak
Next

Lesson 2: Value & Earning Power