MODULE 3

MONETARY SYSTEM

After this lesson, the reader must be able to comprehend and demonstrate mastery of the
following:

1. Origin of Money
2. Function of Money

Introduction

History of Philippine Money

Philippine money–multi-colored threads woven into the fabric of our social, political and
economic life. From its early bead-like form to the paper notes and coins that we know today,
our money has been a constant reminder of our journey through centuries as a people relating
with one another and with other peoples of the world.

Pre-Hispanic Era

Long before the Spaniards came to the

Philippines in 1521, the Filipinos had
established trade relations with neighboring
lands like China, Java, Borneo, Thailand and
other settlements. Barter was a system of
trading commonly practiced throughout the
world and adopted by the Philippines. The
inconvenience of the barter system led to the
adoption of a specific medium of exchange –
the cowry shells. Cowries produced in gold,
jade, quartz and wood became the most
common and acceptable form of money
through many centuries.

The Philippines is naturally rich in gold. It was used in ancient times for barter rings, personal
adornment, jewelry, and the first local form of coinage called Piloncitos. These had a flat base
that bore an embossed inscription of the letters “MA” or “M” similar to the Javanese script of the
11th century. It is believed that this inscription was the name by which the P hilippines was
known to Chinese traders during the pre-Spanish time.

Barter rings made from pure gold, were hand fashioned by early Filipinos during the 11th and
the 14th centuries. These were used in trading with the Chinese and other neighboring countries
together with the metal gongs and other ornaments made of gold, silver and copper.
Spanish Era
1521-1897

The cobs or macuquinas of colonial mints

were the earliest coins brought in by the
galleons from Mexico and other Spanish
colonies. These silver coins usually bore a
cross on one side and the Spanish royal coat-
of-arms on the other.

The Spanish dos mundos were circulated

extensively not only in the Philippines but the
world over from 1732-1772. Treasured for its
beauty of design, the coin features twin
crowned globes representing Spanish rule over
the Old and the New World, hence the name
“two worlds.” It is also known as the Mexican Pillar Dollar or the Columnarias due to the two
columns flanking the globes.

Due to the shortage of fractional coins, the barrillas, were struck in the Philippines by order of
the Spanish government. These were the first crude copper or bronze coins locally produced in
the Philippines. The Filipino term “barya,” referring to small change, had its origin in barrilla.

In the early part of the 19th century, most of the Spanish colonies in Central and South America
revolted and declared independence from Spain. They issued silver coins bearing revolutionary
slogans and symbols which reached the Philippines. The Spanish government officials in the
islands were fearful that the seditious markings would incite Filipinos to rebellion. Thus they
removed the inscriptions by counter stamping the coins with the word F7 or YII. Silver coins
with the profile of young Alfonso XIII were the last coins minted in Spain. The pesos fuertes,
issued by the country’s first bank, the El Banco Español Filipino de Isabel II, were the first paper
money circulated in the Philippines.

Revolutionary Period
1898-1899

General Emilio Aguinaldo, the first

Philippine president, was vested with the
authority to produce currencies under the
Malolos Constitution of 1898. At the
Malolos arsenal, two types of two-centavo
copper coins were struck. Revolutionary
banknotes were printed in denominations of
1,5 and 10 Pesos. These were handsigned by
Pedro Paterno, Mariano Limjap and
Telesforo Chuidian. With the surrender of General Aguinaldo to the Americans, the currencies
were withdrawn from circulation and declared illegal currency.

American Period
1900-1941

With the coming of the Americans 1898,

modern banking, currency and credit
systems were instituted making the
Philippines one of the most prosperous
countries in East Asia. The monetary system
for the Philippines was based on gold and
pegged the Philippine peso to the American
dollar at the ratio of 2:1. The US Congress
approved the Coinage Act for the Philippines
in 1903.

The coins issued under the system bore the

designs of Filipino engraver and artist,
Melecio Figueroa. Coins in denomination of one-half centavo to one peso were minted. The
renaming of El Banco Espanol Filipino to Bank of the Philippine Islands in 1912 paved the way
for the use of English from Spanish in all notes and coins issued up to 1933. Beginning May
1918, treasury certificates replaced the silver certificates series, and a one-peso note was added.

The Japanese Occupation

1942-1945

The outbreak of World War II caused serious

disturbances in the Philippine monetary
system. Two kinds of notes circulated in the
country during this period. The Japanese
Occupation Forces issued war notes in big
denominations. Provinces and
municipalities, on the other hand, issued
their own guerrilla notes or resistance
currencies, most of which were sanctioned
by the Philippine government in-exile, and
partially redeemed after the war.
The Philippine Republic

A nation in command of its destiny is the message

reflected in the evolution of Philippine money
under the Philippine Republic. Having gained
independence from the United States following
the end of World War II, the country used as
currency old treasury certificates overprinted with
the word "Victory".

With the establishment of the Central Bank of the

Philippines in 1949, the first currencies issued
were the English series notes printed by the
Thomas de la Rue & Co., Ltd. in England and the
coins minted at the US Bureau of Mint. The
Filipinization of the Republic coins and paper
money began in the late 60's and is carried through to the present. In the 70's, the Ang Bagong
Lipunan (ABL) series notes were circulated, which were printed at the Security Printing Plant
starting 1978. A new wave of change swept through the Philippine coinage system with the flora
and fauna coins initially issued in 1983. These series featured national heroes and species of flora
and fauna. The new design series of banknotes issued in 1985 replaced the ABL series. Ten years
later, a new set of coins and notes were issued carrying the logo of the Bangko Sentral ng
Pilipinas.

As the repository and custodian of country's numismatic heritage, the Museo ng Bangko Sentral
ng Pilipinas collects, studies and preserves coins, paper notes, medals, artifacts and monetary
items found in the Philippines during the different historical periods. It features a visual narration
of the development of the Philippine economy parallel to the evolution of its currency.

Inflation

What Is Inflation?

Inflation is a quantitative measure of the rate at which the average price level of a basket of
selected goods and services in an economy increases over some period of time. It is the rise in
the general level of prices where a unit of currency effectively buys less than it did in prior
periods. Often expressed as a percentage, inflation thus indicates a decrease in the purchasing
power of a nation’s currency.

Inflation can be contrasted with deflation, which occurs when prices instead decline.

Understanding Inflation

As prices rise, a single unit of currency loses value as it buys fewer goods and services. This loss
of purchasing power impacts the general cost of living for the common public which ultimately
leads to a deceleration in economic growth. The consensus view among economists is that
sustained inflation occurs when a nation's money supply growth outpaces economic growth.

To combat this, a country's appropriate monetary authority, like the central bank, then takes the
necessary measures to keep inflation within permissible limits and keep the economy running
smoothly.

Inflation is measured in a variety of ways depending upon the types of goods and services
considered and is the opposite of deflation which indicates a general decline occurring in prices
for goods and services when the inflation rate falls below 0%.

Causes of Inflation

Rising prices are the root of inflation, though this can be attributed to different factors. In the
context of causes, inflation is classified into three types: Demand-Pull inflation, Cost-Push
inflation, and Built-In inflation.

Demand-Pull Effect

Demand-pull inflation occurs when the overall demand for goods and services in an economy
increases more rapidly than the economy's production capacity. It creates a demand-supply gap
with higher demand and lower supply, which results in higher prices. For instance, when the oil
producing nations decide to cut down on oil production, the supply diminishes. This lower
supply for existing demand leads to a rise in price and contributes to inflation.
Additionally, an increase in money supply in an economy also leads to inflation. With more
money available to individuals, positive consumer sentiment leads to higher spending. This
increases demand and leads to price rises. Money supply can be increased by the monetary
authorities either by printing and giving away more money to the individuals, or
by devaluing (reducing the value of) the currency. In all such cases of demand increase, the
money loses its purchasing power.

Cost-Push Effect
Cost-push inflation is a result of the increase in the prices of production process inputs.
Examples include an increase in labor costs to manufacture a good or offer a service or increase
in the cost of raw material. These developments lead to higher cost for the finished product or
service and contribute to inflation.

Built-In Inflation

Built-in inflation is the third cause that links to adaptive expectations. As the price of goods and
services rises, labor expects and demands more costs/wages to maintain their cost of living. Their
increased wages result in higher cost of goods and services, and this wage-price spiral continues
as one factor induces the other and vice-versa.

Theoretically, monetarism establishes the relation between inflation and money supply of an
economy. For example, following the Spanish conquest of the Aztec and Inca empires, massive
amounts of gold and especially silver flowed into the Spanish and other European economies.
Since the money supply had rapidly increased, prices spiked and the value of money fell,
contributing to economic collapse.

Types of Inflation Indexes

Depending upon the selected set of goods and services used, multiple types of inflation values
are calculated and tracked as inflation indexes. Most commonly used inflation indexes are
the Consumer Price Index (CPI) and the Wholesale Price Index (WPI).

The Consumer Price Index

The CPI is a measure that examines the weighted average of prices of a basket of goods and
services which are of primary consumer needs. They include transportation, food, and medical
care. CPI is calculated by taking price changes for each item in the predetermined basket of
goods and averaging them based on their relative weight in the whole basket. The prices in
consideration are the retail prices of each item, as available for purchase by the individual
citizens. Changes in the CPI are used to assess price changes associated with the cost of living,
making it one of the most frequently used statistics for identifying periods of inflation or
deflation. The U.S. Bureau of Labor Statistics reports the CPI on a monthly basis and has
calculated it as far back as 1913.

The Wholesale Price Index

The WPI is another popular measure of inflation, which measures and tracks the changes in the
price of goods in the stages before the retail level. While WPI items vary from one country to
other, they mostly include items at the producer or wholesale level. For example, it includes
cotton prices for raw cotton, cotton yarn, cotton gray goods, and cotton clothing. Although many
countries and organizations use WPI, many other countries, including the U.S., use a similar
variant called the producer price index (PPI).

The Producer Price Index

The producer price index is a family of indexes that measures the average change in selling
prices received by domestic producers of goods and services over time. The PPI measures price
changes from the perspective of the seller and differs from the CPI which measures price
changes from the perspective of the buyer
In all such variants, it is possible that the rise in the price of one component (say oil) cancels out
the price decline in another (say wheat) to a certain extent. Overall, each index represents the
average weighted cost of inflation for the given constituents which may apply at the overall
economy, sector or commodity level.

The Formula for Measuring Inflation

The above-mentioned variants of inflation indexes can be used to calculate the value of inflation
between two particular months (or years). While a lot of ready-made inflation calculators are
already available on various financial portal and websites, it is always better to be aware of the
underlying methodology to ensure accuracy with a clear understanding of the calculations.
Mathematically,

Change in Inflation = (Final CPI Index Value/Initial CPI Value)

Say you wish to know how the purchasing power of $10,000 changed between Sept. 1975 and
Sept. 2018. One can find inflation index data on various portals in a tabular form. From that
table, pick up the corresponding CPI figures for of the given two months. For Sept. 1975, it was
54.6 (Initial CPI value) and for Sept. 2018, it was 252.439 (Final CPI value). 3 Plugging in the
formula yields:

Rise in Inflation = (252.439/54.6) = 4.6234 = 462.34%

Since you wish to know how much $10,000 of Sept. 1975 would be in Sept. 2018, multiply the
rise in inflation factor with the amount to get the changed dollar value:

Change in dollar value = 4.6234 * $10,000 = $46,234.25

To get the final dollar value of the end period, add the original dollar amount ($10,000) to the
change in dollar value:

Final dollar value = $10,000 + $46,234.25 = $56,234.25

This means that $10,000 in Sept. 1975 will be worth $56,234.25. Essentially, if you purchased a
basket of goods and services (as included in the CPI definition) worth $10,000 in 1975, the same
basket would cost you $56,234.25 in Sept. 2018.

Pros and Cons of Inflation

Inflation can be construed as either a good or a bad thing, depending upon which side one takes,
and how rapidly the change occurs.

For example, individuals with tangible assets, like property or stocked commodities, may like to
see some inflation as that raises the value of their assets which they can sell at a higher rate.
However, the buyers of such assets may not be happy with inflation, as they will be required to
shell out more money. Inflation-indexed bonds are another popular option for investors to profit
from inflation.
People holding cash may also not like inflation, as it erodes the value of their cash holdings.
Investors looking to protect their portfolios from inflation should consider inflation-hedged asset
classes, such as gold, commodities, and Real Estate Investment Trusts (REITs).

Inflation promotes investments, both by businesses in projects and by individuals in stocks of

companies, as they expect better returns than inflation. An optimum level of inflation is also
required to promote spending to a certain extent instead of saving. If the purchasing power of
money remains the same over the years, there may be no difference in saving and spending. It
may limit spending, which may negatively impact the overall economy as decreased money
circulation will slow overall economic activities in a country. A balanced approach is required to
keep the inflation value in an optimum and desirable range.

High, negative, or uncertain value of inflation negatively impacts an economy. It leads to

uncertainties in the market, prevents businesses from making big investment decisions, may lead
to unemployment, promotes hoarding as people flock to stock necessary goods at the earliest
amid fears of price rise and the practice leads to more price increase, may result in imbalance in
international trade as prices remain uncertain, and also impacts foreign exchange rates.

Controlling Inflation
A country’s financial regulator shoulders the important responsibility of keeping inflation in
check. It is done by implementing measures through monetary policy, which refers to the actions
of a central bank or other committees that determine the size and rate of growth of the money
supply.

In the U.S., the Fed's monetary policy goals include moderate long-term interest rates, price
stability and maximum employment, and each of these goals is intended to promote a stable
financial environment. The Federal Reserve clearly communicates long-term inflation goals in
order to keep a steady long-term rate of inflation, which in turn, maintains price stability.

Price stability—or a relatively constant level of inflation—allows businesses to plan for the
future since they know what to expect. It also allows the Fed to promote maximum employment,
which is determined by non-monetary factors that fluctuate over time and are therefore subject to
change. For this reason, the Fed doesn't set a specific goal for maximum employment, and it is
largely determined by members' assessments. Maximum employment does not mean zero
unemployment, as at any given time there is a certain level of volatility as people vacate and start
new jobs.

Monetary authorities also take exceptional measures in extreme conditions of the economy. For
instance, following the 2008 financial crisis, the U.S. Fed has kept the interest rates near zero and
pursued a bond-buying program—now discontinued—called quantitative easing. Some critics of
the program alleged it would cause a spike in inflation in the U.S. dollar, but inflation peaked in
2007 and declined steadily over the next eight years. There are many complex reasons why QE
didn't lead to inflation or hyperinflation, though the simplest explanation is that the recession
itself was a very prominent deflationary environment, and quantitative easing supported its
effects.
Consequently, the U.S. policymakers have attempted to keep inflation steady at around 2% per
year. The European Central Bank has also pursued aggressive quantitative easing to counter
deflation in the eurozone, and some places have experienced negative interest rates, due to fears
that deflation could take hold in the euro zone and lead to economic stagnation. Moreover,
countries that are experiencing higher rates of growth can absorb higher rates of inflation. India's
target is around 4%, while Brazil aims for 4.25%.

Hedging Against Inflation

Stocks are considered to be the best hedge against inflation, as the rise in stock prices are
inclusive of the effects of inflation. Since any increase in the cost of raw materials, labor,
transport and other facets of operation leads to an increase in the price of the finished product a
company produces, the inflationary effect gets reflected in stock prices.

Additionally, special financial instruments exist which one can use to safeguard investments
against inflation. They include Treasury Inflation Protected Securities (TIPS), low-risk treasury
security that is indexed to inflation where the principal amount invested is increased by the
percentage of inflation. One can also opt for a TIPS mutual fund or TIPS-based exchange traded
fund (ETFs). To get access to stocks, ETFs and other funds that can help to avoid the dangers of
inflation, you'll likely need a brokerage account. Choosing a stockbroker can be a tedious
process due to the variety among them.

Gold is also considered to be a hedge against inflation, although this doesn't always appear to be
the case looking backwards.

Example of Inflation
Imagine your grandma stuffed a $10 bill in her old wallet in the year 1975 and then forgot about
it. The cost of gasoline during that year was around $0.50 per gallon, which means she could
have then bought 20 gallons of gasoline with that $10 note. Twenty-five years later in the year
2000, the cost of gasoline was around $1.60 per gallon. If she finds the forgotten note in the year
2000 and then goes on to purchase gasoline, she would have bought only 6.25 gallons. Although
the $10 note remained the same for its value, it lost its purchasing power by around 69 percent
over the 25-year period. This simple example explains how money loses its value over time
when prices rise. This phenomenon is called inflation.
However, it is not necessary that prices always rise with the passage of time. They may remain
steady or even decline. For instance, the cost of wheat in the U.S. hit a record high of $11.05 per
bushel during March 2008. By August 2016, it came down to $3.99 per bushel which may be
attributed to a variety of factors like good weather condition leading to higher production of
wheat. This means that a particular currency note, say $100, would have gotten a lesser quantity
of wheat in 2008 and a greater quantity in 2016. In this case, the purchasing power of the same
$100 note increased over the period as the price of the commodity declined. This phenomenon is
called deflation and is the opposite of inflation.

While it is easy to measure the price changes of individual products over time, human needs
extend much beyond one or two such products. Individuals need a big and diversified set of
products as well as a host of services for living a comfortable life. They include commodities
like food grains, metal and fuel, utilities like electricity and transportation, and services like
healthcare, entertainment, and labor. Inflation aims to measure the overall impact of price
changes for a diversified set of products and services, and allows for a single value
representation of the increase in the price level of goods and services in an economy over a
period of time.

Extreme Examples of Inflation

A handful of currencies are fully backed by gold or silver. Since most world currencies are fiat
money, the money supply could increase rapidly for political reasons, resulting in inflation. The
most famous example is the hyperinflation that struck the German Weimar Republic in the early
1920s. The nations that had been victorious in World War I demanded reparations from
Germany, which could not be paid in German paper currency, as this was of suspect value due to
government borrowing. Germany attempted to print paper notes, buy foreign currency with
them, and use that to pay their debts.

This policy led to the rapid devaluation of the German mark, and hyperinflation accompanied the
development. German consumers exacerbated the cycle by trying to spend their money as fast as
possible, expecting that it would be worthless and less the longer they waited. More and more
money flooded the economy, and its value plummeted to the point where people would paper
their walls with the practically worthless bills. Similar situations have occurred in Peru in 1990
and Zimbabwe in 2007–2008.

Inflationary Period of Martial Law

Martial Law and its Aftermath, (1972-86)

The Philippines found itself in an economic crisis in early 1970, in large part the consequence of
the profligate spending of government funds b y President Marcos in his reelection bid. The
government, unable to meet payments on its US$2.3 billion international debt, worked out a
US$27.5 million standby credit arrangement with the International Monetary Fund (IMF) that
involved renegotiating the country's external debt and devaluing the Philippine currency to P6.40
to the United States dollar. The government, unwilling and unable to take the necessary steps to
deal with economic difficulties on its own, submitted to the external dictates of the IMF. It was a
pattern that would be repeated with increasing frequency in the next twenty years.

In September 1972, Marcos declared martial law, claiming that the country was faced with
revolutions from both the left and the right. He gathered around him a group of businessmen,
used presidential decrees and letters of instruction to provide them with monopoly positions
within the economy, and began channeling resources to himself and his associates, instituting
what came to be called "crony capitalism." By the time Marcos fled the Philippines in February
1986, monopolization and corruption had severely crippled the economy.

In the beginning, this tendency was not so obvious. Marcos's efforts to create a "New Society"
were supported widely by the business community, both Filipino and foreign, by Washington,
and, de facto, by the multilateral institutions. Foreign investment was encouraged: an export-
processing zone was opened; a range of additional investment incentives was created, and the
Philippines projected itself onto the world economy as a country of low wages and industrial
peace. The inflow of international capital increased dramatically.

A general rise in world raw material prices in the early 1970s helped boost the performance of
the economy; real GNP grew at an average of almost 7 percent per year in the five years after the
declaration of martial law, as compared with approximately 5 percent annually in the five
preceding years. Agriculture performed better that it did in the 1960s. New rice technologies
introduced in the late 1960s were widely adopted. Manufacturing was able to maintain the 6
percent growth rate it achieved in the late 1960s, a rate, however, that was below that of the
economy as a whole. Manufactured exports, on the other hand, did quite well, growing at a rate
twice that of the country's traditional agricultural exports. The public sector played a much larger
role in the 1970s, with the extent of government expenditures in GNP rising by 40 percent in the
decade after 1972. To finance the boom, the government extensively resorted to international
debt, hence the characterization of the economy of the Marcos era as "debt driven."

In the latter half of the 1970s, heavy borrowing from transnational commercial banks,
multilateral organizations, and the United States and other countries masked problems that had
begun to appear on the economic horizon with the slowdown of the world economy. By 1976 the
Philippines was among the top 100 recipients of loans from the World Bank and was considered
a "country of concentration." Its balance of payments problem was solved and growth facilitated,
at least temporarily, but at the cost of having to service an external debt that rose from US$2.3
billion in 1970 to more than US$17.2 billion in 1980.

There were internal problems as well, particularly in respect of the increasingly visible
mismanagement of crony enterprises. A financial scandal in January 1981 in which a
businessman fled the country with debts of an estimated P700 million required massive amounts
of emergency loans from the Central Bank of the Philippines and other government-owned
financial institutions to some eighty firms. The growth rate of GNP fell dramatically, and from
then the economic ills of the Philippines proliferated. In 1980 there was an abrupt change in
economic policy, related to the changing world economy and deteriorating internal conditions,
with the Philippine government agreeing to reduce the average level and dispersion of tariff rates
and to eliminate most quantitative restrictions on trade, in exchange for a US$200 million
structural adjustment loan from the World Bank. Whatever the merits of the policy shift, the
timing was miserable. Exports did not increase substantially, while imports increased
dramatically. The result was growing debt-service payments; emergency loans were
forthcoming, but the hemorrhaging did not cease.

It was in this environment in August 1983 that President Marcos's foremost critic, former
Senator Benigno Aquino, returned from exile and was assassinated. The country was thrown into
an economic and political crisis that resulted eventually, in February 1986, in the ending of
Marcos's twenty-one-year rule and his flight from the Philippines. In the meantime, debt
repayment had ceased. Real GNP fell more than 11 percent before turning back up in 1986, and
real GNP per capita fell 17 percent from its high point in 1981. In 1990 per capita real GNP was
still 7 percent below the 1981 level.