How does money work?

Everybody wants money, right?

We need money to fulfil our necessities like food, clothes, shelter, etc. How can these pieces of paper and coins let us buy a bunch of our desires and necessities? It is because these papers have "value". If you tried to pay for something with a piece of paper, you might run into trouble. But when the piece of paper was designated as official currency then we may fulfil our desire.

Okay, but from where does the value come from? All right let's begin the journey of understanding things from the beginning. Grab yourself a coffee and a comfortable couch.

Money or currency is used as a medium of exchange in any transaction.

Previously money was backed by an asset and most recently by Gold, which means that the value of money depends upon the value of gold. During the Gold Standard, we could in principle exchange our paper currency with Gold. The Gold Standard ended in the year 1933.

After that, we have, what is termed Fiat Money. This means the paper currency has no asset backing it, only the commitment of the federal government.

So how is money created?

The process of the creation of money is so simple that people can’t believe it or won’t believe it. Accepting this fact below would mean that majority of the people have been scammed for their entire lives.

It is created by the banks (run by regular people like us) by giving out loans as a principle and that's the where money is created, today usually in a digital form in an account. The actual thing here we need to understand is, that this money creation is not actual money creation. There is no physical money created.

When a bank makes a loan, it doesn't actually lend out any of its own money. Instead, it creates the loan money out of thin air and adds it to the borrower's account. The borrower then uses this money to purchase whatever they want. When the loan is repaid, the money is simply destroyed.

What about the physical money creation then?

Central banks can create money at will and without limit, but it is also their job to keep the economy stable, so they follow certain principles. They cannot just print money on and on. Well, should not sound better than "cannot", because there are some examples in history where some of them did actually. But, the thing is for economic stability they should not. But, they might buy or sell government bonds to regulate the total supply of money in circulation and to avoid inflation or deflation.

A central bank is essentially an entity that manages a nation's money supply and it can loan money to the government with interest. When the government needs more money than it received from taxes, they ask the Treasury Department (i.e the government department that is in charge of handling a country's money). Treasury then receives a bond from the government. The treasury through the banks gives bonds to the central banks. The central banks then write cheques for the bonds and hand them to the bank. At this exchange at the banks, money is created and it can be used to pay government bills.

Where do central banks get money to be able to write this cheque?

They get money from nowhere! They just invent it. When we write the cheque there must be a sufficient amount in our account to cover the cheque. But when the central banks write a cheque, there is no bank deposit on which that cheque is drawn. When the central bank writes a cheque it is creating money. They're writing cheques and creating money from an account that has no money in it. The money the central banks create can be used as legal tender to buy things and it makes its way into the real economy. If we did it, we would go to jail because it is illegal.

Does money come from a loan?

All loans invent money, If we take a loan from a commercial bank also the central bank creates that money. But the thing is new money makes the value of money decline. All countries are in debt there is no country whose debt is zero. More debt means people spend more money which leads to a rise in production. And when production rise there will be also growth in Gross Domestic Product(GDP). The USA has a huge economy where the country contains 28.43$ Trillion debt whereas Nepal has 13.16 billion$ which means the USA GDP is high and the country is richer than others.

Debt= Money

A loan or debt is real money. If people stop to take loans or debt then new money cannot enter. When the government and people take a loan then the central got a chance to circulate new money. But the impact is that overall the value of money will be declined. In earlier days we can get one Biscuit at Rs.5 but now the same biscuit is at Rs.20. From the 2008 depression phase, things get costlier day by day.

This was about the money, we daily use for were not aware of or we do not care to understand in that depth. With this blog, I expect that we got a better understanding of money and got the opportunity to learn something new.

Thank you for reading.