One of the key features of any modern economy is the use of money. Money is a unique good in that it is used as a store of value. Nonetheless, it follows the same rules of economics as any other good.
Primitive economies use barter. That is, they trade objects directly to improve their fortunes. However, barter has definite limitations, since it may not be possible to find someone willing to trade a given good in a given amount at a given time. Thus there is a need for a good that is used specifically as a store of value.
Many different goods have been used as money, but some are better than others. There are certain properties of money that are desirable. It should not decay over time. It should have high value per weight, so as to be easily transportable. It should be divisible. It should be of uniform quality. Perhaps most important, it should not be possible to counterfeit.
Putting all this together, we find that gold and other precious metals are the best type of money. For convenience, certificates redeemable for gold could be used.
When our country was founded, just such a monetary system was created. However, it has since been changed so that the government can print paper money that is not redeemable for anything. This is called fiat money.
What are the consequences of creating more money? When the supply of a good increases, we expect its price to drop. What does it mean for the price of money to drop?
Remember that money is only useful because it can be exchanged for something else. With a given amount of money in existence, prices are established for various goods. An equilibrium is reached with some frequency of exchanges of money and goods.
When more money is introduced into the system, it chases the same amount of goods. Stores start selling out of goods. People find that their money cannot as readily be exchanged for goods. The same is true for retailers. Thus the value of money decreases. Since the values of goods have not changed, more money is required to exchange for them. Thus prices increase.
When government creates more money out of nothing, this is called inflation of the money supply. The logic above shows that a necessary consequence of this inflation is an across-the-board increase in prices. This general increase in prices is what is most commonly known as inflation. This popular nomenclature conflates consequence with cause.
As mentioned above, one of the most important features of money is to not be easily counterfeited. When counterfeiters pass off phony money, they steal some of the value of everyone else's money. That is why counterfeiting is a crime that is punished harshly by the government.
As in many other areas of life, however, the government engages in the same practices that it forbids others to do. There is no distinction in principle between counterfeiting and inflation of the money supply. Both rob existing money of its value.
At best, inflation is simply another form of taxation. However, it is a particularly dangerous form of taxation, since most people don't realize that they are being taxed. When government inflates the money supply, the resulting general increase in prices is typically blamed on "greedy businessmen" and the like, rather than the true culprit, the government.
All too often, the demand for more and more money to finance war, entitlements, or other out-of-control government spending leads government to print more and more money. The amount printed increases exponentially as government attempts to wring the last remaining value out of people's money. This is known as hyperinflation. This explains the phenomenon of the amount of money increasing thousands or millions of times within short periods. Hyperinflation destroys people's savings and wrecks economies.
Thankfully, America has avoided hyperinflation. However, our government does inflate the money supply at a smaller level. While the inflation rate is almost always in the single digits, the effect of inflation compounds over time. Since the creation of the Federal Reserve in 1913, our money has lost 95% of its value. (See this inflation calculator.) To put it another way, government stole 95% of the value of our money.
Understanding the economics of money is necessary to prevent such disasters.