Understanding where money comes from is key to any child's financial education. Here's how to explain it to them in simple terms.
What is money?
Money is a:
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Medium of exchange: It’s used to buy and sell goods and services and is a way to exchange value without having to barter.
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Unit of account: Money is used to measure the value of goods and services. This makes it easy to compare prices and make economic decisions.
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Store of value: Money can be stored and used to purchase goods and services in the future. This makes it a way to save for the future and protect against inflation.
Money can take many forms, including coins, paper currency, and electronic money. Today's most common form of money is fiat currency, which is government-issued currency not backed by a physical commodity such as gold or silver.
For this reason, money - wherever you are in the world - enables you to exchange it for goods you want and need, such as food, clothes, a house, or a car.
Related: Teaching kids about money
How did money start?
Historically, money developed as a way to solve the problems of barter. Barter is a system of exchange where goods and services are traded directly for each other. However, barter is inefficient and difficult, especially when trading for goods and services that are not of equal value.
Money solved the problems of barter by providing a common medium of exchange. This means that people could trade any good or service for money and then use that money to purchase other goods and services. This makes trading and comparing the prices of different goods and services easier.
The earliest known forms of money were commodities, such as gold, silver, and copper. These commodities were valuable because they were scarce and durable. They were also easy to divide and transport.
However, gold, silver, and copper took a lot of work to carry around, so goldsmiths began storing gold coins for customers and issuing receipts. These could then be converted back into gold whenever it was needed. By the 16th century, people started using these receipts instead of gold coins, which became a forerunner to today's banknotes.
How does money work?
Money is a system of value that allows the exchange of goods in an economy. Here’s how to explain how money works to your child in a simplified way. In this example, money circulates between the different people involved in producing and selling bread.
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A farmer grows wheat and sells it to a miller for money.
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The miller grinds the grain to make flour and sells it to a baker for money.
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The baker uses the flour to make bread and sells this to the grocer for money.
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The grocer sells the bread and uses the money to buy food from the farmer.
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The farmer then has money to buy seeds to plant more wheat to make more money.
Types of money in the UK economy
There are two main types of money in the UK economy:
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Cash: Cash is money in the form of banknotes and coins. The Bank of England issues it, making it legal tender in the UK.
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Bank deposits: Bank deposits are physical money held in bank accounts.
Cash accounts for a relatively small proportion of the money supply in the UK, making up around 3%. The vast majority of money in the UK is in the form of bank deposits. Bank deposits can be used to make payments electronically, such as through debit cards and online payments. They can also be used to withdraw cash from ATMs.
Why do we use bank notes?
Banknotes originated around 1745 and have been used ever since. These notes were originally IOUs for gold deposited at the bank. Like the receipts goldsmiths gave, the banknotes were used to pay for things, as the same value in gold-backed them.
However, the link between banknotes and gold, known as the Gold Standard, ended in 1931. Since then, banknotes have been a form of 'fiat money': paper money made legal tender (an accepted form of payment) by a government that is not convertible to gold or any other asset but is made legal tender by the government.
What gives banknotes their actual value?
Trust gives banknotes their value. As people who use money, we trust that banknotes can be exchanged for the things we want to buy. This is because money has a store of value as it is something that can be invested, stored in a bank, left in a safe at home, and then later used to purchase something in the future. We also trust that the banks that handle and look after our money won't lose it as they insure the money they are looking after.
Where do banks get their money from?
Commercial banks (high street banks) get their money from everyday customers who deposit money and borrow money via bank loans.
How do banks earn money?
Commercial banks earn their money by providing and earning interest from mortgages, auto, business, and personal loans. Customer deposits (savings and earnings) give banks the money to make these loans.
Government regulation controls how much money banks can earn. This is because banks can collapse if they lend too much money or lend to people who cannot pay it back.
How can I explain this in simple terms to kids?
For younger kids, you can explain that a bank is a place that looks after people's money and lends money to people to help them buy things.
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A deposit is when you put the money you earn into a bank to look after and keep safe.
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You can then use/spend this money via your bank debit card or cash withdrawal at a bank ATM whenever you need to buy something.
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Interest is when the bank pays you for the money you keep in a savings account at their bank.
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A loan is usually for big purchases like a house or car. Over 18s can then borrow money from the bank, but they need to pay the money back AND pay extra in the form of interest.
How do people earn money?
As part of their financial education, kids need to know that money is something that is worked for and created so they can start to work towards their own financial goals. Explain that money comes from:
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Working
Teach your kids from a young age about the value of money and how money is earned from work. You can show them that they can make money in a variety of ways. Set chores and tasks for them and offer them pocket money for the work or create specific jobs that allow them to earn more money. For example, looking after your pet, clearing and mowing the lawn, babysitting for younger siblings, and even doing extra homework.
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Investing
Explain that another way to get money is by putting your saved money to work so it can grow and earn more money for the future; this is called investing. Putting money in a savings account is one way to make it grow; another is to invest in stocks and shares, though money goes up and down with shares, so you can lose money too.
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Gifts
Money also comes from other people in the form of gifts, or inheritance. Explain to your kids that some people become wealthy from their families because when older family members pass away, they leave them with money.
How GoHenry can help your child understand money
GoHenry's mission is to make every kid smart with money. The card and app are packed with great features that help teens/kids safely and securely learn about money, from saving to smart spending. In-app Money Missions make learning about money fun and engaging with videos and quizzes covering everything from saving to budgeting. Parents can set flexible parental controls in the GoHenry app and receive real-time spending alerts whenever their kids/teens use their GoHenry teen prepaid debit card/kids’ prepaid debit card. You can also create savings goals and recurring pocket money payments.
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