What money actually is?

For most of history, people just traded things. You grow something, I make something, we swap. That is called barter.

Barter is great in a small village where everybody knows everybody, but it falls apart as soon as the group grows. Why? Because for a trade to happen, you need something the other person wants, and they need something you want - at the same time.

Take a look at what happens when you're holding some pão de queijo and you need shoes:

Painful, right? Four trades, and four strangers who happened to line up. Now imagine doing that to pay rent. Or for a surprise visit to the dentist.

The invention nobody signed

Somebody, actually many somebodies in many places, had the obvious idea: what if we all agree on one thing that everybody accepts in every trade? It doesn't even have to be useful. It just has to be easy to swap for everything else. That is money.

Not every object makes good money, though. A few properties kept showing up:

• Durable: it can't rot. A banana is a terrible currency, because by Friday your life savings are black and sad.
• Divisible: you need to buy a coffee and, someday, a house. It has to split into tiny pieces and stack into big ones.
• Scarce: if anyone can get more of it for free, like sea water, it is worth nothing.
• Accepted: the most important one. Money works because everybody else agrees it works.

Civilizations that never met each other kept landing on the same answer: shiny metals like gold and silver. Rare, hard to fake, they don't rot, and you can cut them into coins.

From gold to trust

For a long time, the paper in your pocket was basically a receipt. The government kept gold in a vault, and every bill stood for a piece of it. To print more money you needed more gold. That was the gold standard, and it had one great feature: it made governments keep their hands to themselves.

Naturally, they got tired of that. Over the 20th century, one country after another quietly walked away from it, and in 1971 the United States made it official: no more swapping dollars for gold. Imagine a restaurant that lets you pay with a voucher for years, and one day announces the voucher is now just a really nice piece of paper. Same energy.

Today's money, whether it is the real, the dollar or the euro, isn't backed by a vault of anything. It works because we trust the government and the central bank not to go wild with it. Economists call it fiat money, from the Latin for "let it be done". Which is a very honest name, because it is exactly what the printing press operator said.

It is very practical, and also a little scary: the amount of money in the world is now a decision made by people. The same kind of people who can't agree on where to have lunch.

Brazil has a long history with this. In a few decades we went through a parade of currencies, each one launched with great confidence, each one chopping zeros off the bills like a barber with a grudge. In the early 90s prices were climbing by roughly 2,000% in a single year. A supermarket employee would walk around all day with a price gun, changing labels, and by the time they finished the first aisle the first aisle was wrong. People got paid and ran to the store before lunch, because by dinner the money was already worth less. The real, in 1994, finally tamed it. We are still a little traumatized, honestly.

Inflation: the ruler that shrinks

Here is the part that most of us (me included, for years) nod along to without really getting.

Money follows supply and demand too. When something gets more abundant, each unit is worth less. So when there is a lot more money around, each coin is worth less, and it takes more coins to buy the same thing.

That is the heart of inflation. Not "things got expensive", but "money got weaker".

A small but important distinction: prices can also jump for other reasons. A frost kills the strawberries and strawberries get pricey. That is a price change. Inflation is when prices in general keep drifting up, year after year, because each unit of money buys a little less.

It is slow, so you barely notice. Which is exactly the problem. Here is what it does to the same basket of stuff over twenty years, at 6% a year:

Look at the two lines. The cash in the drawer never loses a single coin, and still buys less every year. That is why people call inflation a silent tax, and the best part is that the one collecting it never has to send a bill.

And it doesn't hit everybody the same way:

People who own things that rise with prices are protected. People who only hold cash are not.

That is one reason countries with out-of-control inflation tend to get more unequal: the people with assets coast, and the people with a salary and a drawer fall behind.

You can see a shadow of this from Brazil. There was a time in the 2000s when a dollar cost less than 2 reais. In recent years it has cost more than 5. An exchange rate has its own causes, so it isn't a perfect measure, but it tells the story: our money got weaker.

Interest rates: the price of money

If cash melts a little every year, you don't leave it in a drawer. You lend it.

An interest rate is the price of money: what a borrower pays to use your money for a while. When you put money in a savings account or a bond, you are lending it to a bank or to the government, and they pay you interest for it.

The number to watch is the gap between the two:

In the chart above, money earns 10% while prices rise 6%, so you really gain about 4%. Flip it around, 5% interest against 6% inflation, and you quietly lose ground even though the number in your account keeps going up.

And then comes the magic part: interest compounds. Interest on top of interest, for a long time:

With interestJust the money you put in

After 30 years you put in $180,000. The rest is interest on interest.

Time does most of the work. We will be back to that idea a lot.

So, what is money?

Money is an agreement. Inflation is that agreement slowly weakening. An interest rate is what you are paid for lending it out while it weakens.

That is the foundation. This is the first post of a series about personal finances, and the next ones get to the part that touches real life: how much you actually need to live well, why an emergency fund is the most boring and most important thing you can own, and why done is better than perfect.