What Is Money And How Is It Created?

what is money

Before paper money there was still trade between people. Beyond swapping one product or service for another, it made sense to use money to allow trades between people who didn’t just want to swap one item for another. Lots of things have been used for money, including cattle, alcohol, cigarettes, tools, knives, and shells.

When gold and silver coins were used for money, they were used because the metals are scarce and have intrinsic value, but it is heavy, hard to transport, and risky. They can also be melted down, mixed with cheaper metals, and recast into coins that are worth less. That is called debasing the currency.

Today central banks and commercial banks all over the world create money out of thin air by accepting deposits from customers, and then loaning most of it out. They can’t loan all of it out, because they might not be able to pay everyone out if people decided to get their paper money out all at once. That is called a bank run.

The bank needs to hold a required reserve of 10% usually depending on the country, so if you deposit $100 into your bank, the bank can then loan out $90 to someone else. You still have $100 in the bank, and the person who borrowed the money now has $90 deposited in their bank electronically, meaning the bank owes the customer $90.

When the $90 is deposited into another deposit account, that bank can now also loan out 90% of that deposit to someone else, and so a single $100 deposit can grow to $900 of created electronic money.

Money does not exist until a loan is created. It used to be the case that the bank had to keep gold deposits to the value of the paper money they issued, but that is no longer the case. A bank note is basically an IOU promising to pay the bearer, it doesn’t have any intrinsic value itself.

Paper money is created by central banks, and electronic money is created by commercial banks. Paper money accounts for around 5% of the total money supply in circulation, whereas electronic money now accounts for 95% of the money in circulation.

When more money is created it devalues the currency, as measured by inflation. This is a hidden form of tax that everyone pays for in the form of higher priced goods and services.

People spend 8 to 10 hours a day working for pieces of fancy rectangular printed paper or digits on a computer screen which have no intrinsic value, yet the government are happy to charge tax on those earnings, and tax goods and services purchased with that paper or electronic money.

Governments around the world use the taxes collected from the population to pay for interest on loans they take out from central banks, national health care programs, social security benefits, and national defence.

There has to be another way right? I believe that way could be cryptocurrency. Alternative methods of payment and storage of value like bitcoin are decentralised, outside the control of central banks and governments, cannot be devalued by policies such as quantitative easing, and may fall outside the scope of many taxes.

When more people adopt using cryptocurrency for trading with each other it will take away the power of central banks.

Let me know if this blog post has changed your perception of money in the reply section below.

About James Winsoar 116 Articles
James Winsoar has been marketing online since 1999 when he launched what was then the world's first commercial mobile phone ringtone company. He has since created several internet marketing software programs and courses. He now teaches people how to make more money in less time by leveraging the power of the Internet.

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