How Banks Create Fiat Money
How Banks Create Fiat Money
Money is the most important economic concept around the world and it has a strong cultural influence on the people of different countries. Money has an extremely wide meaning and can mean different things to different individuals and is not necessarily used interchangeably with other things. In fact, this notion actually started as a value judgment between what a person has to sell to earn a living and what he/she has to save to avoid starvation. The concept of money came to be associated with slavery in Africa where cattle were considered a form of currency. In ancient civilizations, metals such as gold and silver were used as money while today paper money is commonly used as an alternative to these precious metals.
A common example of money is a foreign currency that a person may want to exchange for another form of currency. For instance, the dollar may be exchanged for Japanese Yen in order to buy a car in Australia. The Australian dollar is very valuable because it is very strong against the dollar which is the common currency in most Asian countries. Thus, the purchase of a car in Australia may be translated to you saving USD 10k. Money is used to facilitate trade, and is usually issued by a nation as a legal tender to ensure the payment of taxes.
Money may also be referred to as currency or commonly known as a financial product. This commodity has been in existence for thousands of years and remains to be the most important economic product in the world. One of the most widely used money products is silver. Silver is a precious metal and is used as a standard for trading between commercial establishments all over the world. Thus, every nation’s central bank is usually able to control a significant amount of silver in reserve. Gold is also a useful commodity as it is used as a store of value and as a medium of exchange.
Money is also called fiat money. Fiat money, which can be derived from a fiat bank, is defined as a standardized unit of account created by a government. In contrast to fiat money, a fiat currency is based on nothing other than faith. Thus, the value of a fiat currency is not based on any actual physical commodity.
Money is produced from gold, silver, and/or copper, and is a key part of the global money supply. Governments intervene in the money supply by inflating or deflating the money supply, depending on their desires. In the US, this intervention is done through the operation of the federal reserve banks. In a fiat money system, a central bank is allowed to use its discretion to change the money supply, adjusting the quantity of bank notes that are in circulation, or the rate at which bank assets are bought and sold.
This action alters the face value of the base commodities (in this case, gold and silver) and changes the purchasing power of the base money supply. To understand how money changes into money, it helps to take a look at how commodity money (such as the dollar) normally changes into money. When you go to purchase food at your local supermarket, you might pay with a credit card, which then takes you over to a cashier who then composes a check for the total amount of your order. The check is an unsecured loan that gives you the right to access a vault in which to hold your valuables until you have paid off the entire outstanding balance. At this point, you can either choose to hand over your valuables at this point, or walk away. However, with gold and silver in addition to legal tender, both options are rendered useless, because the money that you would have given the bank in the form of a loan is now either held in the vault, or has been converted from commodity money to some form of standardised asset (monetary currency) at the hands of the bank itself.
Therefore, to explain how banks create money, we need to take a look at the process by which banks give loans to people, rather than using banknotes (which are actually not-money, but bonds or other securities). Instead, what banks do is convert debt (the money that you owe them) into a form of asset, which they can then sell on for profit. This process typically goes like this: when you go to buy a new car, you usually get the money along with a promise to repay it (sometimes known as ‘bondage’) on a fixed date. Banks make money on their’service’ to the customer, rather than on the sale of commodities.
Today, most people use both gold and silver in different forms; so what this means is that the relative value between these two precious metals is actually subject to changes more rapidly than is the value of any other type of commodity money. When you think about how money circulates through the economy, you will see that there is no centralised body, and the rates of exchange that arise tend to be affected by the overall state of the economy. This is because it is the state of the economy which determines the conditions under which different forms of currency will be exchanged.