How does debt, credit, and money work?

Obviously, it would be impossible to entirely explain such complex subjects as debt, credit, and money in a few short paragraphs, which is why this post includes the video, below, which is a very good introduction to the topic. However, a few definitions offer an appropriate place to begin:

• A debt generally refers to something that is owed by a borrower, or debtor, to another party, known as a lender, or creditor. In the broader realm of finance, a debt is most often subject to certain contractual terms which require that the amount of the debt – the principal – be paid back within a certain time frame and usually with an added premium, or interest, which is a percentage of the amount borrowed, and is considered payment for the use of the borrowed amount, or loan. Debts can be considered “secured” if the creditor has recourse to specific “collateral.” For example, when an individual borrows money to buy a house, the debt is secured by the house, itself. If the debt is not paid according to the terms of the loan, the creditor may claim the house. An “unsecured” debt has no specific collateral attached to it. Credit card debt is unsecured. Whenever a debt is unpaid, the borrower is considered to be in “default.”

• Credit is a form of trust. It allows one party, the creditor, to provide money or other resources to another party, the borrower, with the promise that it will be repaid at some later date. The creditor lends the money, or makes the loan, with the explicit understanding that he will be reimbursed for the loan amount – the principal – with the added benefit of receiving an agreed upon fee – the interest – for the use of the loaned money. There are many different types of credit in modern society, e.g. consumer credit, bank credit, investment credit, etc., but in each case, the basic dynamic is the same. Without credit, it would be all but impossible for our economic system to work, since in many cases, for example, in regard to consumer credit, the cost of something, a house or a car, is generally more than an individual can afford at one time. The extension of credit allows a person, a business, or even a government to make a purchase which will then be repaid with funds that can only be amassed over time.

• Money is a medium of exchange that is used for the payment of goods and services, as well as the repayment of debts that have been extended on credit. In modern societies, money, itself, unless it is specie, i.e. made of a semi-precious metal, has no intrinsic worth; it is most often a piece of paper, or note, that merely represents the value of something that has been agreed upon by all who use it. This is known as “fiat” money. Fiat money is actually a fairly recent invention, and as you will see in the video, it was first used to represent an amount of actual gold bullion that was the accepted measure of wealth in pre-industrial, European societies. Before fiat, or representative, money became the accepted medium of exchange, primitive societies employed “commodity” money – shells, foodstuffs, silver or gold coins, or other objects that possessed intrinsic worth.

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