Hi Traders it's Nicholas Puri here.
As I have mentioned in previous videos, it's important to have a broad understanding of
what occurs in the financial world.
By doing so, we will know how to interpret the developments we read about in the news
for our own fundamental analysis and trading.
For all economic analysis we do for our trading, the starting point is often going to be the
central bank.
Therefore you can expect this to be a reoccurring theme in these videos.
However, before we can get onto the often complex and detailed explanations of certain
events and outcomes relating to central bank activity and the banking system in general,
it's important to understand some of the basics, which we can then build upon with the more
complicated topics later.
We'll start with a subject that provides the backdrop for the entire world of finance including
investing and trading - the monetary system.
To make sense of a monetary system, first we need to understand the role of money.
This may sound like a strange thing to say, since we are so accustomed to the concept
of money that we rarely consider what its actual purpose is.
However, this fundamental concept is an essential starting point before we move onto discussing
monetary systems in the next video and eventually finding our way to current events and concerns
in global banking that will affect the markets and ultimately our trading.
In macroeconomics, money is typically considered to have three functions:
Firstly, it is a generally accepted medium of exchange.
Secondly, it is a store of value.
Thirdly, it serves as a unit of account in which prices are quoted.
When people think about the purpose of money, the first function I just mentioned is the
main one that comes to mind: money is a generally accepted medium of exchange.
This also happens to be the most important function of money.
Let's think about what a world would be like without a generally accepted medium of exchange.
Imagine you are a mechanic; if people need their car to be fixed, you can provide that
service for them.
After years of working, your tools are now getting very worn out and need to be replaced,
so you find someone who makes the tools that you need.
However, without a medium of exchange, the only way to get the items you need would be
to agree some sort of trade.
You can offer your services as a mechanic and in exchange you would be given tools to
replace your worn out ones.
This sort of trade is called bartering.
Goods or services are exchanged for goods or services which are believed to be of a
similar value.
With a bartering system, if the two people involved in the trade are both in need of
something the other person has to offer, this is called a 'double coincidence of wants'
and this is the only way a transaction can take place.
But when you consider the amount of different goods and services we need on a daily basis,
the chances of finding a double coincidence of wants on every thing you need is very low.
Instead, we need something that is generally accepted as a medium of exchange and this
is where money plays a role.
Rather than trading your services as a mechanic for the tools that you need, instead you can
receive money for your services as a mechanic from someone that actually needs that service
and you can use that money to pay for your tools from someone else.
As a mechanic your service is very immediate in its nature, you can't have an inventory
full of your mechanical services.
If someone needs a mechanic, you can perform the service at that exact moment in time.
In a bartering system, this means you can only make the exchange for goods or services
at the moment in time that someone needs your service.
Likewise, take the example of a farmer who has milk from their cows.
If they have a particularly good season, they can't save the milk until next year just in
case things don't go to plan.
The milk will spoil and it will no longer have any value.
In both of these examples, the solution is to be able to trade your goods or services
for something that allows you to store the value and use it only when you need it.
The obvious solution for this is money, which will need to have characteristics that allow
you to store it without it being ruined or losing its value.
When it comes to a bartering system, it becomes very difficult to assign comparable values
to goods and services.
For example, how many planks of wood would it take to have the same value as the time
it takes a plumber to fix a leaky sink?
What number of chickens would you need to have the same value in an exchange for a pair
of Ray Ban sunglasses?
We need a common measure of value that allows us to create prices for each good or service.
Therefore meaning we can transact at an appropriate value, since everything is given its value
based on the generally accepted unit of account.
This is the third function of money, in that it gives us the opportunity to share that
common unit of price.
So to sum it all up, money at its most fundamental level serves three important functions for
us on a day to day basis.
It acts as a generally accepted medium of exchange, it offers a store of value and it
provides a unit of account in which prices are quoted.
Now that we know why money is so important and what role it plays for us.
We now need to understand how this money is controlled and how it comes into circulation.
In the next video we will cover these topics by explaining what a monetary system is, why
it's so important and the main types of system that can be used.