How money really works

The paper in your wallet is worth nothing as paper. A 100-RON banknote costs a few cents to print. Its value comes from one thing: everyone agrees to accept it in exchange for goods and services. This is called fiat currency: money that has value because a state backs it and people trust it, not because it is backed by gold or another physical good.

Before money, people used barter, swapping goods directly (a hen for sacks of wheat). The trouble with barter is that it needs a “double coincidence of wants”: I must want what you have, exactly when you want what I have. Money solves this: it is a universally accepted go-between.

Who “makes” money

In Romania, the National Bank of Romania (BNR) issues physical banknotes and coins. But most of the money in the economy doesn't exist physically. It is figures in bank accounts, created when commercial banks grant loans. When the bank gives you a 50,000-RON loan, that money appears in your account. It isn't taken from a safe, it is created electronically, backed by your promise to repay.

The three functions of money

• Medium of exchange: you can buy bread without needing the baker to want exactly what you produce.
• Unit of account: prices are expressed in the same unit, so you can compare the value of two different things.
• Store of value: you can save purchasing power today for later (although, as you'll see in the next lesson, inflation partly undermines this function).