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Derrick Spies
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What is money?

26 November 2012, 07:15

What is money? Or more specifically what is money in today's economy?

Today's money is known as Fiat currency (from the Latin meaning 'let it be done') and has no intrinsic value, as it is not backed by reserves of any kind. In other words you cannot exchange the money in your wallet for its value in gold or silver (reserves) like you were able to in the past.

Instead, a country's currency is pegged at a value determined on its overall buying power in relation to other currencies, most notably the American dollar.

Essentially it has value because our government tells us it has value by calling it legal tender, and because we believe it has value.

Money is usually defined as a medium of exchange; a unit of account and a store of value.

I would add to that and say that money is debt.

Why is money debt?

Any money produced has interest attached to it. When the South African Reserve Bank releases money into the economy, it attaches interest to it, what we call the repo rate - currently at 5%.

What this means though is that whenever new money is issued into the economy, it immediately has the expectation of having to create more money in order to pay for its creation. (The repo rate is the rate the central bank charges the commercial banks - Standard Bank, Absa, FNB etc-  who in turn charge an even higher rate, known as the prime rate, from the general markets.)

Currently, for every R100 released by the South African Reserve Bank, it expects R105 back.

So where does the other R5 come from?

That's easy.  We get it from the marketplace, you say.

When we sell something, we add value to it. So let's say we use the R100 to make a plastic Santa Claus, we sell it for R120. We are then able to pay back the bank the R5 extra and we even have R15 left over for ourselves.

But what about the person who gives you the money, or the person who had it before him?

Remember ALL money created bears interest. So irrespective of where it is in the market system, there will always be a shortfall.

But the items themselves can increase in value, you say.

This is true. Items do increase in value. This is called inflation and is not a good thing for money. Rather than lifting the system out of debt, it erodes the value of money.

Remember money is needed to purchase the item. The higher the cost of the item becomes, the less buying power - the less value - the individual unit of money has.

This is why the Reserve Bank can target inflation by easing the interest rates on money.  By reducing the cost of the original money, we do not feel as much pressure to increase the value of items to try and pay back the debt created by having money.

But there is still debt. Money cannot make more money without increasing debt.

Isn't the debt covered by the growth in the economy, you ask?

Again, economic growth is driven by the pursuit of money. Investors (people with money or who borrow money) will build factories and create products to sell to make more money. the more money they make - the more money in circulation - the more the economy grows.

But ultimately, where does the money come from? The Reserve Bank. No-one can have money that has not been issued by the bank and ALL money bears interest. In other words, the more the economy grows, the larger its debt burden.

But I'm not taking foreign currencies into consideration, you say.

Fair enough, but remember, all currencies in today's economy are Fiat, so whether it's the pound, the euro, the dollar or the yen, they have all been released into the financial system by a reserve bank or equivalent and have interest attached.

So any direct inflows of money from one country to another, while easing the receiving country's debt, results in outflows from the other country, increasing their own debt.

So what if Reserve Banks were to have a negative interest rate?

Well, the scenario has been proposed and is even being seriously considered as a way to address the current financial crisis. Japan is looking at implementing negative rates and some US government bonds are already offering negative rates.What a negative interest rate means is that you would be charged interest for keeping money in a bank and would earn money on your debt.

It would certainly drive up demand for debt. People would want to pay off their accounts first to get rid of their money and then use their credit cards as much as possible to drive up their debts in order to earn money.

Banks would be quick to give out loans and would want to reduce their cash reserves, people would keep cash on hand, rather than in a bank where they would have to pay for storing it.

It could lead to a new surge in economic growth, something that is desperately needed in today's stalling global economy.

But it may also have unforeseen consequences.

Remember money has no intrinsic value, and if having money costs you money and owing money earns you money, then the very nature that money would take on in a negative interest environment undermines its own value. Simply having it reduces its value.

Rather than inflation we could see a rapid deflation in prices as people get rid of assets in exchange for debt.

And what happens when the Reserve Banks have to return to positive interest rates? When people suddenly have to start paying for their debts they would have created?

My conclusion

The system of Fiat money cannot last. The evidence is all around us. The debt burden is everywhere and the more money that is created the greater the debt burden becomes.

The question is, what happens when the system collapses? When the value we give money no longer exists. When the money we have can no longer buy things we need and the debt that is owed cannot be repaid?

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