Money. We all love it. But do you actually know what money is? What is its value? What are the policies that govern the monetary system?
The monetary system is the most misunderstood and taken for granted. Never the less, understanding the monetary system is critical to understanding why our lives are the way they are.
Unfortunately, economics is usually viewed as one very difficult to understand and boring topic. Lots of math, a lot of charts… who cares about that? Right?
Actually, no. The complexity behind the monetary system is because we take it for granted and don’t care to look deeper into it.
There are some things that you need to understand about money like, where does it come from? How does it get its value? What is inflation?
How does money come to be?
The United States government decides that it needs money. So it calls the national reserve bank and requests the amount. The Federal Reserve Bank buys the amount requested in US bonds.
The government creates some treasury bonds and values those bonds in the sum of the amount requested and sends them to the Federal Reserve Bank.
The bank then prints money-notes in the value of the requested amount and exchanges them for the bonds. Once the government places that money-notes into a bank account, it actually becomes tender money.
In reality, this transaction happens electronically on a computer. No paper is used at all, nothing is printed. Only records of the values are stored. Yes, including the money itself.
In the USA only 3% of the currency is actually available in real money. The rest is stored in credit forms.
One important note is that the government bonds are actually a form of debt. Once issued they mean that the government owes the Federal Reserve Bank an X amount. An in return, the FRB just issues a record that an X amount is now available for the US government in a commercial bank account.
By low, the commercial bank has to keep a 10% of the deposit as reserve. The value may vary from time to time. The amount left, the 90% is called an excessive deposit.
If someone takes a loan in the amount of the money created from that specific bank and puts it into their own account in another bank. That other bank has to keep 90% of the money as an excessive reserve and can keep it in circulation.
What gives those notes their value?
Money takes its value from other money that already exists. New money steals value from the existing money supply. Now that new money is available for the public, money value starts diminishing and loses some of its purchasing power. This is usually known as Inflation.
What is Inflation?
The monetary system in essentially inflationary. Creating money without increasing market’s goods and services will always cause inflation and cause the currency to lose some of its value. There’s always an inverse relation between the amount of money in circulation and the purchasing power of that currency.
Since money comes from debt as we said earlier, usually, the more money there is, the more debt there is.
Money can only come from loans and debts. If everyone was able to pay off their debts including the government, there won’t be any money in circulation.
Money comes with an extra tax… “Interest”. Since all the money comes from banks in the form of loans and has to be returned with an interest, this means that only the original amount that was put in circulation is available to return. But what about the interest?
For example. If the Federal Reserve Bank issues 10 Billion and places them into one or multiple commercial banks. And people take the money from banks in the form of loans and have to return that money with interest. Where would the extra money – the interest – come from?
Nowhere. The amount of money owed to the banks will always exceed the amount of money available. This is why inflation is a constant in most economies.
Did you find this interesting? Let me hear your thoughts.