I've had a lot of physiological psyche courses (psyche degree), so I'll try to help you guys out with the current theories on this. It's so huge though, so it might work best if you guys ask me specific questions. I'll start by talking about what Stryder said. Also if anyone else has ideas or theories of their own, feel free to chip in. Like I said, this is just what is currently thought (Although there is a lot of evidence to support it).
Once upon a time it was thought the mind worked on electrical impulses, and then they moved to thoughts of chemical reactions.
From my understanding though the body is comprised of Acids, and there is a charge that firing neurons makes that can stimulate or lower the viscosity of the acids reaction with the other chemicals.
Actually
all of these processes are still thought to be involved in neural communication. Within a neuron an action potential is created, which is kind of like an electric pulse. This electric pulse propagates down the axon (kind of like a long branch that extends from the nucleus of the cell). A bundle of these axons is what is known as a nerve. The axon ends at another cell (generally another neuron if within the brain). At the end of the axon chemicals are released because of the action potential. These chemicals are called neural transmitters (NT). The chemical messengers travel across the small gap (called a synapse) to the neighboring neuron and bind to receptors on it. Depending on the type of NT it will push that neuron towards either having an action potential itself, or inhibit it from doing so. This is kind of the basic of neural transmissions, some of you may know a lot of this already. In this way, the brain is a set of complicated switches. (this strongly relates to a binary computer analogy also)
As for acids, there are many kinds of amino acids that are involved in neural communication indirectly. Can't think of anything specific right now.
How most thoughts are stored in the actual brain is like having a crystal infront of some photogenic paper and allowing light to flow through it.
This analogy seems to suggest that our memories are like pictures that are stored in a neural network. Most peoples memories aren't like this (except for "photographic" memories???, haven't looked into that much though). Memories are more of a confabulation of events. It's as if you store a few key points, and when you remember it, you brain just fills in the gaps to make it more continuous. Crucial aspects seem to be stored in a series of switches and the rest is filled in. Cactus jack, this is why you remember yourself in the third person a lot.
The understanding of this acidic nature gives a clue of how, over time a memory can deteriorate. (It also explains how dead braincells are re-utilised in the growth of new ones etc)
This is not how the psychological scientific community views this. As far as I know, there isn't any evidence to support this. If you clarify this it might make more sense to me.
Ok, remember those receptors on the receiving cell, well they can be reduced or increased. Meaning that the neurotransmitters (NT) have a greater or reduced chance to bind to them. Some NTs will cause the voltage of the cells to go up (excitatory NTs), while others will cause the voltage of the cell to go down (inhibitory NTs). If the cell is pushed to a certain level, called threshold, the neuron will have an action potential itself. So it's like a tug of war, some NTs will be pushing towards threshold and others will push away from it. The falling in the mud of the inhibitory side would be like the action potential.
This next part is going to be described very basically for right now. If a cell has many action potentials within a short period of time the cell will increase the number of receptors at the synapses that are excitatory at that time when the cell had an action potential. This makes the cell more readily able to fire the next time around. If these syapses are inactive for extended periods of time the number or receptors may reduce making the cell less likely to fire. This is the basis for how we form memories and how memories "degrade" over time.
There is a debate in the psych realm of whether memories actually "degrade" or if new info "interferes" with old info. In my opinion it's probably both.
There is also debate on when you forget something, whether it's a decay in storage or just an inability to retrieve the info. Again I think it's a little bit of both.
I hope I'm not coming off as trying to be some know-it-all-brainiac-wannabee. It's just that this is my main focus of study and would like to educate you with what I've learned about it. Please fire away with the questions. I'm moving in the next few days here though, so it might be a bit before I can answer them.
-Xenu