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 Economic Freedom
The evolution of money is hurting us
DNA, India Saturday, November 7, 2009

The process by which banks create money is so simple that the mind is repelled. -- John Kenneth Galbraith How did the modern system of money evolve? It all started with the barter system, writes Vivek Kaul in DNA.

The process by which banks create money is so simple that the mind is repelled. -- John Kenneth Galbraith How did the modern system of money evolve? It all started with the barter system. As George Cooper writes in The Origin of Financial Crises - Central banks, credit bubbles and the efficient market. "Long, long ago, the first trade was conducted via barter. All good were exchanged directly for all other goods."


But someone somewhere realised that barter as a mode of exchange is just taking too much time, and the world moved onto gold as a medium of exchange.


Thus the concept of gold as "money" evolved. The thing with gold was that it was indestructible and could be stored for the future.


Once gold became a medium of exchange, it did not take much time for the world to start using gold coins. Having gold coins as a mode of money created its own set of problems.

"Governments, especially when in financial trouble, would recall their coinage, melt it down and reform the metal into more coins with a lower gold content... For government generated a nice new pile of gold for conversion into coins for their own coffers."

But debasement of currency became a huge problem and this led to the development of certificates of gold deposits.


So this led to the development of gold depository banks where "groups of merchants got together to from merchant banks that would hold their gold securely at a central location.


These banks soon realised that the owners of gold rarely came back to collect it. As a result, gold was lying idle with them most of time. So these bankers came up with a money making scheme of their own.


Now, what this did was that "there were always more certificates of deposit in circulation than there was gold in the vaults of banks." This in turn led to crisis situations during which individuals with these certificates landed up at the bank asking for their gold back. The trouble was that the bank did not have enough gold to make good against all the certificates it had issued. As this news spread, more people landed up at the bank, leading to a bank run.

This soon led to a situation where central banks which would fight financial instability being created.


This created the concept of currency notes issued by the government. But what this also did was give the government a monopoly on printing money. And unlike the kings of earlier age, who had to call their gold coins back to debase them, governments could simply print more and more paper money as and when they deemed fit. And this right, as we know, has more or less been responsible for the current financial crisis.

This article was published in the DNA on Saturday, November 7, 2009. Please read the original article here.
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