Money exists only because everyone believes it exists. So if we all started to believe that bananas or bitcoins could pay for our purchases, we would start collecting them and claiming them in return for work.
From the individual’s point of view, money comes from work and you should not leave it to the bottom of your wallet. Saving secures your future.
Why do we even spend money?
Ever since people have exchanged, for example, cereals for butter, there has been a need for some kind of mutual trust, which allows for the exchange of goods without knowing the other party personally. Since everyone believes that money brings goods and services, it is possible to exchange even unknown people. At the same time, one can specialize in individual professions. If we didn’t trade anything with anyone, everyone would have to be equally adept at growing tomatoes for building a house.
On the other hand, if we did not have a single currency in use, every day we would have to remember an immeasurable amount of different exchange rates. If you specialize, for example, in philosophy lectures, you would pay the store at the box office telling what Plato and Socrates were thinking. The shoe merchant pays for the shoes, the owner of the dairy farm for milk. So the average person should remember how valuable milk is compared to shoes, philosophy lectures, or anything else. The soup would still be confused if the milk was spoiled, the shoes would wear faster than those made by another shoemaker, and the lecture on philosophy would be long-winded. In addition, a shoe retailer may not want milk right now, and those interested in a philosophy lecture may not be found nearby.
A solution to this problem was found by tying the value of money to something else, for example squirrel skins, gold or silver. Although precious metal was a means of payment, it was accompanied by banknotes, which were receipts of deposited gold. During World Wars, states issued extra banknote money to finance their warfare. This increase in the amount of money broke the link between the value of precious metals and banknotes. However, the attempt was made to restore the value of money to gold and silver without success – nominally the connection was cut off in the 1970s.
Indeed, money today is mainly about trusting a debtor, such as an entrepreneur or a private individual, to pay off their debt through profits or wage income from goods or services within the agreed time. Finally, money comes from believing in the future.
How do banks and the central bank report to this?
Money comes from banks granting loans. It is a common perception that banks only lend exactly what they have in store somewhere. However, this is not the case; banks hold only a small percentage of the money they borrow. How on earth can bank loans get out of nowhere? If I have a drill to a friend, I need to have a drill before I can lend it.
The bank must keep 10% of its reserves, which in practice means cash or deposits with the central bank.
- Someone goes to the bank to deposit 1000 €, the bank keeps 100 € or 10%.
- The bank lends € 900 to someone else.
- When the loan is repaid, 10% of this, or € 90, is left in the bank and the remaining € 810 is borrowed. -When the € 810 loan is repaid, 10% or € 81 is left in the bank and € 729 is still lent.
Thus, if the reserve requirement is 10%, banks can increase the amount of money tenfold. The reserve requirement may also be another percentage. So the money comes from the bookings on the bank’s balance sheet.
The system works because not all bank customers will demand their money from the bank at the same time. Have you ever heard such a saying: You can’t keep the cake by yourself and eat it at the same time? The saying is not true in this case, because the retail reserve system allows you to invest money efficiently and productively, but also to use it when needed. The downside is that the bank would go bankrupt if everyone wanted to withdraw all their money and clear all their debts in one second. However, governments guarantee bank deposits of up to € 100,000 for individuals.
Individuals handle loan and deposit issues with a commercial bank, while commercial banks handle the same with a central bank. The central bank regulates the amount of money in a country or group of countries and maintains price stability. The central bank can influence the amount of money lent by banks by raising or lowering the key interest rate. They can also control bank lending and lending for short-term bank needs against collateral.
Banks therefore need to assess the likelihood that individuals and companies will be able to repay their debts. If the bank makes a mistake, it is responsible for paying the debt. However, governments and central banks can sometimes help banks.
How is it possible that the whole system has not collapsed?
However, the average person does not have to worry about losing their money at the bank as it is still the safest option to keep money for deposit protection. Banks have been doing the same for hundreds of years. Money comes and goes as before.
Economic growth is ultimately based on the belief that everything will be better in the future. This is possible when new and different inventions are made and efficiency is increased.So far, there have always been new inventions. Governments, communities, companies and individuals are investing in scientific research and other innovations.
Sometimes a new invention has been a bakery on the street corner in a better location, a steam machine or new packaging material.