Ever gave it a thought, how money is actually created. With the total amount of money always increasing in an economy like India its good to know how it is actually created.
If you just thought for a second that money creation takes place by the RBI printing the currency notes and distributing it via the banks, well in that case you just narrowed down the concept of money to just 10%. Yup the notes that you hold account for just 10% well 10.48% to be precise as of March 2019, so in India's GDP of around 158.68 lakh crore physical money/cash accounts only for 16.63 lakh crores.
So what exactly is money?
In a layman's term Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context.The main functions of money are distinguished as: a medium of exchange, a unit of account, a store of value and sometimes, a standard of deferred payment. Any item or verifiable record that fulfills these functions can be considered as money.
So now that we understand money lets move to the creation part!
What if I tell you that YOU are the focal point for creating money.
What to know how?, ever taken a loan or even a interest free EMI. If yes then kudos you have successfully created money for the Economy.
So if you haven't figured out till now, then let me help Money is created by introducing DEBT. So yes all money is created is via Debt
Now Let's analyse this:
Most of the money in our economy is created by banks, in the form of Debts. 96-97% of the money in the economy today is created by banks, whilst just 3-4% is created by the government in the form of government deficits.
The money that banks create isn’t the paper money that bears the logo of the regulatory body RBI. It’s the electronic deposit money that flashes up on the screen when you check your balance at an ATM. Right now, this money (bank deposits makes up over 90% of all the money in the economy. Only 10% of money is still in that old-fashioned form of cash that you can touch.
Banks can create money through the accounting they use when they make loans. The numbers that you see when you check your account balance are just accounting entries in the banks’ computers. These numbers are a ‘liability’ or IOU( I Owe Unto ) from your bank to you. But by using your debit card or internet banking, you can spend these IOUs as though they were the same as Rs.100 notes. By creating these electronic IOUs, banks can effectively create a substitute for money.
Every new loan that a bank makes creates new money. While this is often hard to believe at first, it’s common knowledge to the people that manage the banking system.
Commercial banks create money, in the form of bank deposits, by making new loans. When a bank makes a loan, for example to someone taking out a mortgage to buy a house, it does not typically do so by giving them thousands of pounds worth of banknotes. Instead, it credits their bank account with a bank deposit of the size of the mortgage. At that moment, new money is created.
Like wise the other 3-4% is created by the Government by maintaining a deficit budget and the deficit is financed by introducing Government Bonds.
So yes as soon as you put your pen to the paper to sign the loan documents or if you are agreeing to the conditions of EMI via an online portal you are creating money.
So If someone tells you or taunts you "Paise kya hawa se aate hai", well in that case you can tell him that Yes! Its created out of thin air you just need a pen paper and some legal formalities. Though it has some costs and the repaying it might be a bit problematic but you can always sign another paper. And just in-case its your parents who say it then such explanations are better avoided, If not then it may have certain consequences, but you never know it can be a risk worth taking!
So yes by creating money in this way, banks have increased the amount of money in the economy by an average of 11.5% a year over the last 40 years.
This has pushed up the prices of houses and priced out an entire generation.
Of course, the flip-side to this creation of money is that with every new loan comes a new debt. This is the source of our mountain of personal debt: not borrowing from someone else’s life savings, but money that was created out of nothing by banks. Eventually when the debt burden becomes too high, it results in a wave of defaults that triggers the financial crisis.
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Great read!!