Sunday, February 11, 2007

Creation of Money

Although types of money are easily known and distinguished, the actual nature of money and the manner in which it is created is less easily understood. The fact that commodities such as gold, silver, furs or tobacco leaves have value does not make any of them money. It becomes money only when it is generally accepted as a symbol representing a certain value of goods and services and readily accepted in exchange for other goods and services of commensurate perceived value. Trust in its accuracy and universal acceptance and confidence in the availability of goods and services for redemption are essential criteria. The creation of money is also a subject of considerable confusion and superstition. The creation of commodity money was made possible by the discovery or production of more of the particular commodity, such as gold or barley. As commerce expanded, trade became the primary means for making of new money. Traders supplied goods to their buyers on credit through bills of exchange which the buyer endorsed and promised to pay within a given period of time. Bills endorsed by credit-worthy buyers or their guarantors then become a form of currency that could be used by the note holder to make additional purchases. At a later date banks became the principle source of new money. Banks take in deposits and issue loans to borrowers either by paying out some of the currency receipted on deposit or simply by creating a new deposit in the borrowers account without receiving currency to back it up. By this means banks create many times more money than the amount they receive or hold on deposit. Central banks in turn further multiply the amount of currency and require deposits by printing additional currency and using it to purchase government bonds or by lending it to commercial banks by creating fresh deposits at the central bank for the bank just as the bank does for its own borrowers.


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