This article is about the supply and creation of money by government. For the system of monetary calculation and coordination, see
Price system
.
System by which a government provides money in a country's economy
A
monetary system
is a system by which a
government
provides
money
in a country's economy. Modern monetary systems usually consist of the national
treasury
, the
mint
,
the central banks
and
commercial banks
.
[1]
Commodity money system
[
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]
A commodity money system is a type of monetary system in which a
commodity
such as
gold
or
seashells
is made the unit of value and physically used as money. The money retains its value because of its physical properties. In some cases, a government may stamp a metal coin with a face, value or mark that indicates its weight or asserts its purity, but the value remains the same even if the coin is melted down.
Commodity-backed money
[
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]
One step away from commodity money is "commodity-backed money", also known as "representative money". Many currencies have consisted of bank-issued notes which have no inherent physical value, but which may be exchanged for a
precious metal
, such as gold. (This is known as the
gold standard
.) The
silver standard
was widespread after the fall of the
Byzantine Empire
, and lasted until 1935, when it was abandoned by China and Hong Kong.
A 20th-century variation was
bimetallism
, also called the "double standard", under which both gold and
silver
were
legal tender
.
[2]
Fiat money
[
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]
The alternative to a commodity money system is
fiat money
which is defined by a
central bank
and government law as
legal tender
even if it has no intrinsic value. Originally fiat money was paper currency or base metal coinage, but in modern economies it mainly exists as data such as bank balances and records of credit or debit card purchases,
[3]
and the fraction that exists as notes and coins is relatively small.
[4]
Money is mostly created by banks when they loan to customers. Put simply, banks lending currency to customers, subject to each bank's
regulatory limit
, is the principal mode of new deposit creation.
[5]
The central bank does not directly fix the amount of currency in circulation, nor is central bank money. Although commercial banks create circulating money via lending, they cannot do so freely without limit. Banks are limited in how much they can lend both by regulatory limits and by good management practice, in order to remain profitable and solvent. Prudential regulation also acts as a constraint on banks' activities in order to maintain the resilience of the financial system. And the households and companies who receive the money created by new lending may take actions that affect the stock of money ? they could quickly 'destroy' the money or currency by using it to repay their existing debt, for instance.
[6]
When the
principal
of the loan is being repaid by the borrower that money is erased/destroyed and the bank only keeps the interest as income.
Central banks control the creation of money by commercial banks, by setting interest rates on reserves. This limits the amount of money the commercial banks are willing to lend, and thus create, as it affects the profitability of lending in a competitive market.
[6]
This is the opposite of what many people believe about the creation of fiat money. The most common misconception was that central banks print all the money, this is not reflective of what actually happens.
Today's global monetary system is essentially a fiat system because people can use paper bills or bank balances to buy goods.
[7]
Debt based monetary system
[
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]
A debt based monetary system is when
money creation
is issued as debt from
commercial banks
(primarily). It is essentially
leveraged
margin
that they created themselves, so there is no
interest
that needs to paid on the margin. Large banks are required to have a 10%
reserve requirement
,
[8]
so they can only leverage up to 10 times their
deposits
/
liabilities
. Smaller commercial banks such as
community banks
and
credit unions
have zero reserve requirement.
[9]
The
Federal Reserve
can only create new money as debt as well, during
quantitative easing
they buy
U.S. Treasuries
and
mortgage-backed securities
.
[10]
[11]
When the
principal
is being paid back to the bank that money is erased/destroyed, the bank only keeps the interest from the loan as income.
See also
[
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]
References
[
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]
- ^
"What is monetary system? definition and meaning"
.
BusinessDictionary.com
. Archived from
the original
on 23 December 2017
. Retrieved
25 April
2015
.
- ^
Velde, Francois R., "Following the Yellow Brick Road: How the United States Adopted the Gold Standard".
Economic Perspectives
, 4th Quarter, 2002. Available at SSRN:
http://ssrn.com/abstract=377760
or
doi
:
10.2139/ssrn.377760
- ^
Brent Radcliffe.
"Fiat Money"
.
Investopedia
. Retrieved
25 April
2015
.
- ^
"Money creation in the modern economy: an introduction"
(PDF)
. Bank of England.
- ^
Hockett, Robert C.; Omarova, Saule T. (2017). "The Finance Franchise".
Cornell Law Review
.
102
: 1153?1155.
doi
:
10.2139/ssrn.2820176
.
S2CID
54696766
.
SSRN
2820176
.
- ^
a
b
"Money creation in the modern economy"
(PDF)
. Bank of England.
- ^
"How the Fiat System Works"
.
dummies.com
. Retrieved
25 April
2015
.
- ^
"Reserve Requirements"
.
www.federalreserve.gov
. Retrieved
2024-04-19
.
- ^
https://www.federalregister.gov/documents/2022/12/01/2022-26065/reserve-requirements-of-depository-institutions
- ^
"FRB: Is the Federal Reserve printing money in order to buy Treasury securities?"
.
www.federalreserve.gov
. Retrieved
2024-04-19
.
- ^
Jackson, Andrew; Ryan-Collins, Josh; Werner, Richard; Greenham, Tony.
"Where Does Money Come From?"
.
New Economics Foundation
. Retrieved
2024-04-19
.
External links
[
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]