Understanding where money comes from is a key part of any child’s financial education. Here’s how to explain it to them in simple terms.
What is money?
Money is an accepted exchange system in the form of coins, banknotes and digital money via debit card (money accounted for and transferred by online methods). These forms of money are issued as legal tender by governments of countries. For this reason, money - wherever you are in the world - enables you to exchange it for goods that you want and need, for example, food, clothes, a house, or a car.
Related: Teaching kids about money
How did money start?
Historically, gold and silver were used as money. However, this was hard to carry around so by the 16th century, goldsmiths began storing gold coins for customers and issuing receipts. These could then be converted back into gold whenever it was needed. Over time, people started to use these receipts instead of gold coins, and these became a forerunner to the bank notes we use today.
Why do we use bank notes?
Banknotes originated in 1861 and have been used ever since. These notes were originally IOUs for gold deposited at the bank. Like the receipts given by goldsmiths, the banknotes were used to pay for things, as they were backed by the same value in gold. However, the link between banknotes and gold, known as the Gold Standard, ended in 1971. Since then, banknotes have been a form of 'fiat money': paper money made legal tender by a government that is not convertible to gold or any other asset.
What gives banknotes their true value?
It's actually trust that gives banknotes their value. As people who use money, we trust that banknotes can be exchanged for the things we want to buy. We trust that others will accept them for their face value. We also trust that the banks that handle and look after our money won't lose it.
Where do banks get their money from?
Commercial banks get their money from everyday customers who deposit money and borrow loans.
How do banks create money?
Commercial banks create their money by providing and earning interest from loans such as mortgages, auto loans, business loans, and personal loans. Customer deposits (savings and earnings) give banks the money to make these loans.
What role does the Federal Reserve play?
The Federal Reserve acts as the central bank of the US and is responsible for managing the money supply for our entire economy. The Federal Reserve controls money and keeps the economy in check in a few different ways.
Where does money come from? Overall, the Federal Reserve is responsible for creating money. It does so through buying securities in the free market and adding the same amount of money into the commercial bank reserves. These commercial banks, in turn, increase the money supply in our economy by giving more money out in loans to customers and other businesses.
The Fed is ultimately responsible for creating coins and bills too. Coins are issued through the US Department of the Treasury, and bills are printed by the Bureau of Printing and Engraving. Both are ultimately controlled and issued by the Federal Reserve.
Can banks create as much money as they like?
Government regulation controls how much money banks can create. 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 like houses. Next, describe how banks work:
A deposit is when you give the money you earn to a bank to look after and keep safe.
You can then dip into this money via your debit card or cash withdrawal whenever you need to buy something.
Interest is when the bank pays you for the money you keep in a savings account at their bank.
A loan is for people who don't have enough money to buy something like a house or car; they can then borrow money from the bank. To do this, banks expect people to pay the money back AND pay extra in the form of interest; this is how they make money.
How do people get money?
As part of their financial education, kids need to know where money comes from as early as possible. Once they understand where it comes from and that, overall, it's something that is worked for and created, they can start to work towards their own financial goals. Explain that money comes from:
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 earn money in a variety of ways. Set chores and tasks for them and offer them an allowance 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.
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.
Explain this isn't a very common or easy way to get money, but some people get lucky and win money via the lottery or competition. Point out that the chances of winning the US Powerball jackpot are 1 in 292 million (extremely low considering there are only about 330 million people in the US!).
Money also comes from other people in the form of charity or inheritance. Explain to your kids that some people become wealthy from their families because when older family members pass away they leave them money. But also point out that other people need money from charities to survive and are given money for this purpose. One way to get your child to understand this is to encourage your child to give and then show them how their money can positively impact other people's lives.
How GoHenry can help your child to understand money
The GoHenry prepaid kids' debit card and Money Missions on the GoHenry app are both designed to accelerate your child’s financial education. Children can learn the basics about banking, saving, spending and investing by using their GoHenry card and learning through Money Missions. The GoHenry Money Missions are linked to national financial education guidelines, and feature fun games, quizzes and videos to make learning a fun and interactive experience.
Money Basics is the first of our Money Missions topics for kids to enjoy. If you’re looking to teach your child about the past, present and future of money along with understanding how banks work you’ve come to the right place.