Since the beginning of their existence on earth, humans have needed ways to trade with each other. Initially, there were simple barter systems. One person had wheat and someone else had milk, so they could swap wheat for milk, and both of them end up with both wheat and milk. That simple example didn’t actually go very far. If the person who had milk didn’t want wheat, there was no way for them to do a deal.
There were two ways to fix the barter problem, both of which form the underpinnings of today’s monetary system. One was to find a third item, something both of them could use. Lots of different things have been used as “money” over the years, but the most obvious winners have been gold and silver. So the person with the wheat was not limited to trading only for milk, they could trade for silver or gold, then they could use the silver or gold to get anything else that could be traded for silver or gold. Metals like gold meet a lot of the important criteria for being a good medium of exchange, it’s something everyone agrees is valuable, it’s rare (you can’t create more of it), it’s durable (it won’t decay over time), and it can be divided into small amounts for smaller trades.
The second important development was a credit system where you could keep track of who has how much money. If you get paid by someone, you could just save the money until you need it. Or perhaps you might need something before you have the ability to pay for it. In a ledger system we keep track in a central ledger of who has what. In small societies the credit system could be informal and based on people’s honor or their word, but bigger societies required a more formal system. That more formal ledger system eventually became the banking system, where a trusted third party, the bank, kept track of transactions and balances for everyone. Banks made it possible to do business with people you did not know and might not trust, and to do business over great distances, not just with people who were nearby.
Other changes were made over time. Instead of everyone carrying gold and silver around, the government could keep gold and silver in their vaults, and then issue metal coins (for small amounts) and notes and paper currency (for large amounts) instead. These were easier to transport and handle, and were valuable because they were still backed by gold.
Paper currency (bank notes) were “bearer” notes, meaning they could be used by anyone who was carrying them. Banks also introduced checks so depositors had a way to pay bills without actually withdrawing cash every time. Currency and checks were “negotiable”, meaning they could be given to others, they didn’t have to be used only by the person who first received them. This freed everyone from the need to go to the bank for every transaction and made it much easier to buy and sell things.
In time, all these ways of paying bills and lending money coalesced into formal networks recognized not just within a local area or a country, but across the world. At their heart, all these monetary networks function as an alternative to actually carrying gold around. Currency is used for every day transactions, with the understanding that somewhere in the background gold, or reliable promises to pay, back the currency.
Initially US dollars were backed by actual physical gold held in Ft. Knox, but in the 1970’s, as a part of the war on inflation, the gold standard for the US dollar was eliminated. Instead of being backed by a specific amount of gold, the US dollar is now backed by “the full faith and trust of the US government”.
Money that is not tied to gold or some other precious metal is called “fiat” money, it’s money that can be created out of thin air by the government. There is no longer any guarantee that dollars are redeemable for gold, so there is technically no limit to the number of dollars that can be put in circulation.
Over time, almost every country has eliminated the gold standard for their money. Most world currencies are now fiat currencies. The value of each currency varies, in part, based on how much faith and trust the world has in the government that issued it. As long as US citizens, and the world as a whole, trusts the US government to keep its promises and pay its bills, the US dollar will continue to be safe and valuable.