But what gives money its value? Or does it even have real value? What makes it any more special than any other product of paper and ink?
An economist would tall you that what gives money its value depends on what type of money it is: commodity money, representative money, or fiat money.
Commodity money has a value or use aside from its use as money. During the late eighteenth century, farmers in the Pennsylvania backcountry used whiskey for money. They bought and sold items by the jug. In ancient Rome soldiers were paid in salt. Cows-as-money would fit into this category, too. The idea is simple: if whiskey is money, then you can use it in economic transactions... or you can just drink it if you feel the urge. The money is, itself, a real thing with its own inherent value.
The next type, representative money, can be redeemed for something of real value. In the past, most representative money was backed by gold and silver. Countries pegged the value of their currency to a certain amount of the precious metal and promised to exchange their currency for the metal on demand. In other words, if you had a hundred dollar bill, you could walk into the U.S. Mint and exchange your paper for a hundred dollars' worth of gold. Gold was a real thing with real value; the paper money had value only because it was redeemable for gold.
Finally, we get to fiat money (the stuff in your wallet), which is money because the government says it is. It is not backed by gold or any other substance of real value. It has no real use or value other than its value as a form of currency. And its value is thus set by the market forces of supply and demand, just like everything else. As long as people want dollars, they will have value. If everyone in the world suddenly decided tomorrow that dollars are worthless... well, then they'd be worthless.
Why It Matters Today
If you've watched TV late at night anytime lately, you've probably seen ads hawking gold as "a safe investment in hard times" or something to that effect. While some of those ads seem pretty shady, the truth is that gold has been hot lately.
Some people presume that gold has some kind of fixed, inherent value. But the shiny metal is a commodity just like anything else; its price fluctuates with supply and demand. And lately, demand has been high; the price of gold recently hit an all-time high of more than $1250 an ounce.
Why are so many people looking to get into gold? With a severe recession dragging down economies all around the world, central banks have set very low interest rates at or near zero. Those very low interest rates, many investors believe, eventually cause inflation; thus gold is a wise investment because it will hold its value better than money.
Gold normally isn't a very sexy investment, so the fact that gold has been surging recently suggests a certain distress and pessimism in the markets. Let the hoarding begin!
He used to spend his money on whiskey (think of the former whiskey trade) but now he’s returning with gold.