Let me start off by saying I love money, who doesn't? We need money to survive and thrive in this world, we earn and spend money every day. But have you ever wondered how a piece of paper could be worth so much?
Also, how do banks generate so much money simply by exchanging it nationally and internationally? Money's underlying concept is a fascinating subject. And if you are curious about what money actually is and what gives it value, this article is exactly what you should read to understand how money works.
This post is all about understanding how money works.
UNDERSTANDING HOW MONEY WORKS
Money is nothing more than a piece of verified paper issued by a specific state or country. On the one-pound bill, for example, you'll see words like "I Promise to pay the Bearer on Demand the sum of One Pound" That is to say, the owner of the pound note is promised to be paid the sum of the note in gold or coin.
Students have a lot of confusion surrounding money. How it actually works, how they can make the best use of it, how to spend and how do banks make money - these are questions the answers to which can benefit the young generation. So, in this article, I will talk about some of the most common curiosities people have about money in order to understand how money works.
What Is Money?
Money is just a piece of paper or coin or digital currency that represents how much resources (Like Gold, Silver, etc.) the central bank of your country owes you.
When humanity first started to farm thousands of years ago, we were introduced to the concept of trade. People used to trade things for goods during that time. For instance, if someone required rice and had an extra goat, the man would trade the goat for rice. However, people quickly realised that this wasn't the best method to do business.
People began looking for a different form of transaction soon after. Many historians believe that gold was the first recognized currency used to purchase things, but others disagree. They claimed that silver was the foundation of the entire concept of money.
Whatever it was, with the introduction of currency, the commercial process became considerably more straightforward in regards to how money works.
Enough with the history. I am pretty sure the majority of you have come to learn about the principles of the currency we currently use. We now largely transact with paper (cash) and credit, which is quite different from gold or silver. They were universally valued all over the world, but the value of paper money varies greatly.
Different Types Of Money
Firstly, to understand how money works we need to look at the different types of money. Each variety has its own set of benefits and drawbacks.
As I previously stated, gold and silver were the primary forms of currency in the 1200s. In some countries, silver coins are still used for transactions. It should be obvious to you that paper money is not the only type of currency. Daily, several types of money are utilized all over the world.
I'll go over all of the different types of money we use in the next sections.
In the present era, what is money? It's essentially a government-issued document that can be used for a variety of transactions. Allow me to clarify. A five-pound bill is essentially a piece of paper that can be traded for a similar-valued item. The only difference between it and a regular piece of paper is that it was approved by your government.
The highest value of the cash will be determined by the country's GDP. In Zimbabwe, for example, you might find a million-dollar bill, but you might only be able to buy a chicken with it. A £100 pound note, on the other hand, will cover a weeks’ worth of groceries easily for a small family.
Believe it or not, the credit system opens a passive income path for banks. In the realm of finance, credit is commonly described as an agreement whereby the borrower collects funding or anything of value and pays the bank or lender at a subsequent time, usually with interest.
Credit may also refer to a person's or company's credit history or creditworthiness. In the accounting world, it refers to a financial item that either reduces assets or raises total liabilities on the balance sheet of a firm. Now, how does credit work?
To begin with, credit is a commitment to acquire a commodity or service with a clear guarantee of paying for it later. Credit cards are the most prevalent way of borrowing money nowadays. The institution that issued the card pays back the shop in full and provides credit to the buyer, who may afford to repay the institution over time, as a middleman in the credit arrangement.
Consumer or company creditworthiness also refers to the quantity of money available for borrowing, which is sometimes called credit. Somebody may say, "They have excellent credit, so they don't have to worry about the bank denying their home loan."
Finally, from accounting’s perspective, credit is an increase in revenue and decreases in expense. That basically means a company’s net income is determined by its total credit.
There are several types of credit. Bank credit, often known as financial credit, is the most common type. Credit lines, signature loans, mortgages, and car loans are examples of this type of credit. When a bank loans to a customer, it essentially credits money to a guy, who must repay it at a later date.
Crypto currency is kind of like the coins in an arcade or casino. Only in this case they are digital. They hold a certain amount of value. And that value is largely dependent on how popularly they are used. While money is a representation of how much valuable resources you own.
Crypto is a representation of how much money you own. Unlike regular currencies, crypto is untraceable and not really controlled by central banks.
They use blockchain technology which manages and records transactions. What makes crypto so popular is its level of security. Being untraceable, there is no way to track a crypto transaction back to the participants of that transaction.
Gold (sometimes silver)
It is the simplest form of currency. The value of gold changes with time, but it does hold its value and you can exchange it for things like the loan, house bill, paper cash and so on.
International transactions are paid using gold or a currency that can be converted to gold at a set price under a gold-standard system. If currency rates rise or decrease by more than the cost of moving gold from one nation to another, significant inflows or outflow of gold occur till the prices revert to the administrative level under this system.
Why Can't the Government Print More Money?
Inflation is why governments can’t just make money. When a government decides to print money, the prices of resources also increase. Everyday necessities become unspeakably expensive.
As we’ve already discussed, money represents the resources our country owns. The money you have represents how much of that you own. To make it simpler, let’s assume that right now there are only one hundred one-pound notes in the UK economy. That means the UK as a whole owns £100 worth of precious resources that we can use and trade with other countries.
Money is just numbers on paper. So, no matter how much money the government prints, it will still represent the same total resources the country owns. So, even if the UK government decides to print a 100 more £1 notes, the current total of £200 pounds will still represent the same total resources. And that will lead to the value of the pound note to decrease by half.
Now, how will it effect the citizens of UK? Well, first of all, when importing goods from foreign countries, companies and the government will have to pay more for the same products and resources.
And this increase in import costs will obviously affect their prices in the UK market. Due to the increased costs of imported goods, eventually the price of many domestic goods will also be affected. This means when buying your college supplies and paying for your college tuition, you’ll have to pay a lot more.
While the prices of goods and services might increase rapidly, your annual income of the general population will not. People’s purchasing power will decrease and many people’s economic status will suddenly be downgraded. This is called economic depression.
When To Buy Something?
When buying something you have to make sure how much value it adds to your life. Do you really need it? Is it bringing something positive to your life? If the answer is yes, then buy it. If it is “No”, then don’t.
But this is not that simple. Sometimes value can be an arbitrary concept. Something might not bring you economic value, could bring you mental value instead. A trip to a fair with your friends cannot be considered a bad investment. It’s going to give you the mental strength and motivation to work harder.
The key point to consider when spending is to not be a victim of indulgence. Sure, you need a phone to take photos and communicate with your friends. But there is very little difference in actual real-world value between a £200 phone and a £2000 phone. So, you have to consider what things are actually useful and necessary in your life and spend accordingly.
What Determines The Price Of A Product?
Learning how some things are priced can provide you with the right mindset to spend better and save up. For example, when you decide to buy that iMac for your school work, and you’re on a budget, is that really smart investment? Well, not really.
See, when you are buying something whether it’s food, tech, services or anything else, you are paying for the product itself and related services, you’re paying a certain amount for the vat and you’re sometimes paying for the brand too.
You can find something of similar performance and aesthetics in the laptop market as an iMac of much less. But iMacs and other Apple products hold a certain level of prestige. And that prestige makes them vastly more expensive than equally or even sometimes other more powerful laptops.
Supply and demand also determine the price of products. Diamonds are in reality very common in Africa and abundant. But they are released into the market in very small quantities to keep their prices high. Besides diamonds, many luxury brands follow this process of decreasing supply to increase the value of their products. And, that is a very important factor when it comes to the price of products.
If you are smart with your money, you can look past these allures of exclusivity and avoid buying overly expensive things. Always buy products that are practical and provide you the most amount of value for the least expense.
How Do Banks Make Money?
Banks Usually Make Money Through Service Charges. Banks Also Make Money Through Interests
And Interchange Fees.
Have you ever waited in front of your booth while the machine processes your card wondering, how are banks actually making money? I mean besides the small fees you pay per month (mostly for business accounts) there isn’t much that your bank is charging you. Well, to answer your curiosity, the banks don’t need to.
Firstly, banks make money through banking fees. Account maintenance, overdraft, excessive withdrawal fees, ATM fees – are just to name a few.
Banks also make a huge sum of money through other interests. Student loans, home loans and so many other types of loans are provided by all banks. And the amount of money they generate through them is humongous. So, they can afford to pay for your little conveniences in the hope that you’ll also use their loan services at some point if they can get you habituated to spending using your card.
The third biggest way banks make money is through interchange fees. Sure, banks don’t charge you when you swipe your card at a store. But, they do charge the seller for every transaction.
If you're really unlucky, there are those seller who actually charge the customer directly for paying via credit/ debit card in their shops- avoid those. Always check to make sure there are no extra charges to using your card).
How To Manage Money As A Student?
When you're at college, you're in a wonderful position to learn how to handle your money and develop habits that will help you achieve financial success. You can try to better understand your habits to have a clearer picture of your spending and saving patterns. This will allow you to save money. You can then work toward larger goals, such as paying off student loan debt, travelling, and saving money
Of course, the primary goal of college should be to obtain a high-quality education. But it also gives a fantastic opportunity to acquire the money management skills you'll require for a solid financial foundation in the future. So, you need to start making wise decisions now. Here are some tips that can help students manage their money better.
Fix A Budget
As a university student, it's vital to learn how money works, by learning how to budget and create financial solvency. After a full day of lectures, examinations, and other commitments, the notion of creating a budget may seem daunting. But it's actually rather simple to accomplish.
In terms of personal money, a college budget may be a very good step for you. Your monthly income and spending patterns are revealed when you set a budget and track them. A tight budget doesn't mean you can't have fun, but it does mean that your enjoyment won't interfere with your ability to pay the bills.
Note Your Expenses
Keep track of where your money goes. Review your spending habits on a regular basis to identify where you might decrease costs or spend more efficiently. Until you look at your income and spending, you may not know how much your tiny, everyday purchases add up.
While setting up a budget is one thing, really sticking to it may be quite the challenge. Use apps like Mint or Money dashboard; or simply a pen and paper to keep tabs on your costs to see whether they line up with your actual experience or need to be fine-tuned.
Monzo Current Account For Your Expenses
To take your expense tracking to the next level, open a Monzo Current Account for FREE to stash you money away in separate Pots (one bank account, but you can create as many pots as you need).
Example of Using Monzo
- One pot for Essentials (expenses) such as Rent, Food, Transport and other bills like mobile phone, subscriptions (Amazon prime) etc.
- One pot for Non Essentials such as Eating out and Nights out, clothes, gym membership etc.
- One pot for Holiday savings
- Another pot for Christmas Presents money etc.
You get the idea, you can create pots and even lock/ unlock it till a certain date if you lack self control and discipline when it comes to spending money; all with just one bank account.
PRO TIP: You need to divide the stuff into what counts as essential or non-essential expense to you. E.g. For me, going to the gym is a non-essential expense.
Open A Bank Account For Savings
For this reason, it's vital to start early. If you spend your money first and then save what's left, you'll wind up saving less money in the long run. Instead, pay your expenses first, save some money, and then treat yourself.
However, if you trying to save for the long run in your savings account, the the number one rule is to pay yourself first, before expenses and other bills etc.
"Don't save what's left over after spending, but spend what's left over after saving," Warren Buffet once said. Having a budget is the first step to identifying areas where you can cut costs and save for your long-term goals. As a starting point, here are a couple of suggestions.
- If you discover that you have lesser and lesser money left over in your account on a frequent basis, consider switching to a less costly meal plan.
- Instead of buying new versions, rent or buy old textbooks. Other less priced choices for coursework materials may be available at your college.
- If you need a phone or laptop for your studies, choose a reconditioned model rather than a completely new model.
- Instead of paying for buying a car, consider walking, riding your bike, or utilizing campus transit.
Apply For An Overdraft
A student overdraft (much like a regular overdraft) is essentially a small loan meant to help you get by when you need a little additional cash. It enables you to take out more money than you have in your account.
Overdrafts are beneficial to students since part-time jobs come and go as the academic load increases, and there may be occasions when you want financial assistance. Standard overdrafts may require you to use your wages to repay the amount borrowed, or you may be charged.
An overdraft for students might help you get through the school year without adding to your student loan debt. Because it's really a loan, interest rates may apply. Getting a student overdraft with no interest means you'll be less prone to rack up needless debt.
You could also find additional incentives that appeal to you; for example, some banks provide overdraft services with savings on train travel or other bonuses like food or shopping vouchers or movie tickets. For two to three years, you should be eligible to have a student overdraft.
Your bank may automatically transition to a student account once you graduate, and you should have 2-3 years to repay the interest-free excess.
Why Do Governments Tax Us?
We have governments at the local, state, and national (federal) levels. Legislators (who establish laws), executives (who execute laws), judges, and a variety of other officials make up these governments, aka 'civil servants'. The money that these government employees are paid comes from your taxes.
Taxes come in a variety of shapes and sizes. When you work for a living, you must pay income taxes. A proportion (part) of your earnings is withheld depending on how much money you earned (kept out of your paycheck and sent to the government).
When you buy something in a store, you generally have to pay sales tax, which is a percentage of the item's cost that the business charges. You must pay property taxes on the value of your property if you own it.
Paying your taxes is regarded as a civic obligation, however, it is also a legal necessity. If you don't pay your taxes, the government agency in charge of collecting them, Britain’s HM Revenue and Customs (HMRC), will demand that you do so or risk consequences such as fines or jail time.
The money you pay in taxes is spent in a variety of ways. Your tax payments support common resources like police and firefighters, in addition to supporting the wages of government employees.
Even as a student, if you have a job, you’ll also have to provide income taxes. But you have to earn £12,500 or more before your income is taxable. If your annual income is between £12,500 to £50,000, then you’ll have to pay 20% as tax. If it is beyond that then you might have to pay as high as 40%.
Foreign students who earn just enough to pay for their course fees and living cost, might get a tax break. But, if you earn more than that or have plans to become a permanent UK resident, then you will need to pay taxes on your yearly income.
How To Make Money From Money?
Have you ever heard of the compound effect? The Compound Effect is a concept that describes how tiny, persistent acts may lead to tremendously successful outcomes in both business and life. Using this concept, you can change your life forever as well. Here are a few instances that demonstrate this concept:
A pence that doubles every day for 31 days is worth more than 5 million pounds in cash right now.
Take, for example, three friends who start in the same place- one makes no changes (good or bad), one adds a weekly beer to his diet and watches TV in his spare time, and another makes some little adjustments such as cutting out 200 calories per day and reading 10 pages of a good book every day. Which of these three persons do you believe will be in a better position in two years?
What's the bottom line? The tiny decisions we make on a daily basis have an influence on the outcomes we will see in the future. We may not notice the difference at first, and after 5 months or even a year, things may appear to be virtually the same. But as time goes on, the positive outcomes will stack up.
As a student, I cannot emphasize how important it is for you to start saving up. If you take a look at the early life of Warren Buffet, he started working and investing in the early ages of 9 years old. And he was already earning £72,000 in today’s money, by the time he was a teenager.
His father was a congressman. Yet, he didn’t shy away from odd jobs like delivering newspapers, saving and investing. The initiatives he took as a kid and later as a teenager, made him one of the richest individuals on the planet today.
Students often forget that they’ll have to eventually pay off their student debt. And the longer they wait and more severely will the debt affect them. But if you start saving now, little by little and make some smart investments, you might just be prepared to pay off that debt and even have a head start in life.
Another reason you should start investing is that, as a student you have very little to lose. There are still people who can financially back you up in rough times. And not many people depend on you. So, you are free to take larger risks. That is a luxury you won’t have even only a few years after you graduate. So, start investing early and investing smart. The future you will thank you for it.
For individuals interested in pursuing a career in the business world, understanding the fundamentals of how money works is critical. Knowing how do banks make money and how they work is necessary for gaining a better grasp of the monetary system and using it to your advantage.
This article should have helped to clarify some of the ambiguity around this subject. Thank you for stopping by.
Please share this post with anyone you think it will help. Remember, as students we are all trying to escape the 'broke student cliché' when it comes to money.