Volume: 4 Issues: 22 [September, 2019] pp.

116-125]
International Journal of Accounting, Finance and Business (IJAFB)
eISSN: 0128-1844
Journal website: www.ijafb.com

RISING COST OF LIVING: THE ROLE OF FIAT MONEY

AND MONEY CREATION

Ainul Mohsein Abdul Mohsin1

Fauziah Md. Taib2
Sani Saidu Alhajj3
1
School of Management, Universiti Sains Malaysia (USM), Malaysia, (E-mail: ainabdulmohsin@usm.my)
2
School of Management, Universiti Sains Malaysia (USM), Malaysia, (E-mail: mfauziah@usm.my)
3
School of Management, Universiti Sains Malaysia (USM), Malaysia, (E-mail: sanisaidu@student.usm.my)

Accepted date: 30-07-2019

Published date: 13-10-2019

To cite this document: Ainul Mohsein, A.M., Taib, F.M, & Sani, S.A. (2019). Rising Cost of
Living: The Role of Fiat Money and Money Creation. International Journal of Accounting,
Finance and Business (IJAFB), 4(22), 116-125.
________________________________________________________________________________________

Abstract: The increasing cost of living remains the leading cause of concern for a sizeable
segment of the public. Governments around the world increase money supply in economic
circulation in a bid to induce economic productivity that would later be translated into higher
net economic worth. In the absence of real asset backing, the additional fiat money supplied
would only put more pressure for inflation to rise. This paper attempts to expound that the
increase in the cost of living is instigated by the excess creation of fiat money by banks with no
existent asset backing in the present day monetary system and would not bring about
corresponding increase in economic output. Utilising the secondary data starting from 1990, it
examines the trend of three Southeast Asia countries specifically Malaysia, Thailand and

current phenomenon and substantiate that excess of fiat money is responsible for the high cost
of living and disproportionate increase in the real economy output. In conclusion, our findings
support the argument that the increase in money supply without asset backing is disconnected
to the real economic growth and causing the cost of living to soar and perpetually puts pressure
for the currency to be devalued which is decremental to the development of a country.

Keywords: Cost of Living, Fiat Money, Money Creation, Real Economy Output.
___________________________________________________________________________

Introduction
The long-standing issue about the price of products we buy stays the same or have increase
drastically and the size of goods and produce are getting smaller is never ending. On a daily
basis there are news on the shift of prices that influence our daily budget. The prices of food,
housing, transportation, education, entertainment and health care are on the rise. This is
evidenced and reflected in a survey conducted by the International Islamic University Malaysia
Islam in 2017 which revealed that even though majority of Malaysians are satisfied with their
well-being, most are agitated with issues that affect their finances (Azizan, 2017). Their worries
are mainly related to economic factors such as household income, housing, employment and
116
personal safety. The same anxiety Indonesia and
was very noticeable during the recent 2019 presidential election. The glaring issues that were
debated were on economic stability, high cost of living and the plummeting Indonesian rupiah
in 2018 (Mohamad Salleh, 2019). Although Singapore, another neighbour of Malaysia has
attained the status of a developed country, yet the disquieted concern of its people still lingers
on the topic of rising cost of living. This is visible in the latest Singapore 2019 Budget when it
published that many goods and services in Singapore will get more expensive in the years to
come (Liew, 2019). This same phenomenon is also true in Thailand, another neighbour of
Malaysia. According to the 2018 Suan Dusit Poll, the rise in cost of living is the number one
concern in the Siam Kingdom. Within a span of five years, Bangkok has become the second
most expensive city to live in within ASEAN losing only to Singapore. This is indeed a critical
observation which needs immediate attention. Thus, without we realising it, the increase in cost
of living influence the standard of living of a country. Standard of living refers to the standard
of comfort (Hexter, 1916). (GDP) per
capita measures the standard of living of its people. The growth of the GDP is influence by the
inflation rate. Evidently, inflation arises when there is increase in the cost of living.
Consequently, the standard of living is undeniably linked to the cost of living. What makes the
cost of living to escalate?

There are many factors that cause the rise in the cost of living. We can approach this
phenomenon through various perspectives. Some scholars attribute this phenomenon to interest
rate, wages, employment and other economic factors. One perspective is by looking at the
inflation rate. Friedman (1968) observes that, inflation occurs when there is a constant rise in
the general price level that leads to a unit of currency to buy less than it did in prior period.
Accordingly, inflation decreases the purchasing power of a nation's currency. Noteworthy
studies of monetarists established that inflation occurs when money supply escalates faster that
the rate of national income growth. In contrast, when the money supply increases in line with
real output then there will be no inflation. The current fiat money is prone to inflation. Several
economists claim that fiat money is a factor responsible in aggravating the money supply to
move at an exponential rate (Dwyer and Hafer, 1999). This is because the value of fiat money
is largely based on trust and not on any real assets.

The surge in money supply and increase in inflation will result in high prices of goods and
services and intensify the rise in the cost of living. This will naturally lead people to borrow
more money to make ends meet and establish more debt in the monetary system and
consequently more fiat money in circulation. A further carefully thought-out question one
should consider is when there is an increase in fiat money, what is the legit explanation for the
disproportionate increase in the real economy output?

This paper put forward a contention that the increase in the cost of living is instigated by the
excess creation of fiat money by banks with no existent asset backing in the present day
monetary system and would not bring about similar increase in economic output.

Money Supply, Economic Output And Standard Of Living The Relationship

Theoretically, it is believed that an increase in money supply will lead to an increase amount of
money in circulation and in turn will encourage more investment and spending. The role of
central banks is to control the monetary supply ensuring that the value of money is not
excessively over or under valued. A controlled money supply would result in positive or

117
beneficial economic growth for a country. Implicit in these arguments is the fact that only
central banks have the authority to create and control money supply.

As demonstrated by Werner (2014), printed fiat money supply is controlled by central banks
but the large amount of money creation is actually in the hands of private banks (for great
majority of countries in this world). An estimation of ratio of fiat money and actual money in
circulation is cited to be around 5% to 95% of the central bank and private banks respectively.
Although the creation of money officially with the central banks, in reality it is the private banks
that are responsible to create more money through approved loans (Werner, 2014). Not only
banks can create credit and money, but it can also create money out of nothing through
b
) cited, that as early as 1855 Henry Dunning Mcleod asserted this
observation in his article entitled The Theory and Practice of Banking (Mcleod, 1905). The
same argument was later echoed by Schumpeter (1912) and Hahn (1920) that bank has the
power to create money from nothing. Interestingly, Hahn was a lawyer, an academic but also a
scion of a Frankfurt banking dynasty and was aware of the actual banking practices when he
wrote:

thus the means to fund it. ...The conclusion from the process
described canbe expressed in reserve by saying...that every deposit
that exists somewhere and somehow in the economy has come

Mcleod, Schumpeter and Hahn were the advocates of the credit creation theory of banking.
According to them, individual banks are able to create money contrary to the fractional reserve
theory which argues that individual banks cannot create credits but collectively only the banking
system can do so. Werner (2014)b conducted a study to test these theories to establish if
individual banks are able to create money from nothing. Werner's was first to empirically
establish that banks individually can create money from nothing and validated the credit
creation theory of banking.

Evolution of Goods to Money Backed by Asset

Before there is any fiat money, bartering was used in lieu of money to buy goods or services.
People exchange their agricultural goods for produce from the seas. It is appropriate when the
goods offered by one party is in need by the other party. Nevertheless, when people start
interacting with people that are remotely afar, a problem arises when it comes to the quantum
of exchange. Thus, the formation of money occurs to ease the transaction and to standardise the
unit of exchange. Money can be anything from metal, shell, livestock, leather, salt or grain. By
acknowledging money as a medium of exchange, it spontaneously acquires value. The paper
money that is used in the past, is something we have put some value to it, but it has nothing to
do with the physical value of the paper itself. The value given to the money allows people to
trade goods and services and to also to save for future use. Money becomes valuable because
everybody will accept money as a form of payment for the exchange of goods. Money also ease
the trading process significantly. To facilitate the use of money by traders, many have substitute
to using coins which are made of gold or silver matching to the specified value. Coins are fixed
to the value of gold or silver. Over time, banks started to evolve from using coins to bank notes

for their face value in silver or coins to buy goods and services (Soddy, 1934). In conclusion,
money derives its value by being a medium of exchange, a unit of measurement and a
storehouse for wealth.

118
 Fiat Money
In the past, the value of money is fixed to gold or silver value as mentioned above. By pegging
money to gold or silver, we can ensure the money invested in economic activities can always
be recourse to the value of the gold that backs the money. The current fiat money that we use
everyday, has no intrinsic value, but it is declared to be legal tender as a medium of exchange
by the country government. To put it differently, by the government decree, it is legal to pay
debt using the fiat money even though it is not backed by any asset (Chappelow, 2019). The fiat
money is only backed by the universal faith and trust that it has value and nothing more. The
Transition from Barter to Fiat Money by Joseph Ritter gives a comprehensive learning on this
subject. With the evolution of time, money in today's progressive world is just a special form
of IOU known as a financial asset (McLeay, Radia and Thomas, 2014); a mere promise to pay
in the form of a signed document.

Credit Creation Theory

According to the credit creation theory, banks behave differently from financial intermediaries
because they do not separate customer funds from own funds. Money deposited by the
depositors becomes the legal property of the bank and the depositors are the lenders to the bank.
When the bank gives credits, it will create an imaginary deposit by recording the credits amount
in the borrower's account even though no new deposits have taken place; thus, allowing for the
creation by fairy dust! The bank balance sheet lengthens. Cash, central bank reserves
or balances with other banks are not immediately needed because reserve and capital
requirements only need to be met at particular measurement intervals (Werner, 2014b). The
money creation is achieved through credit creation which is merely an accounting semantic that
does not involve any real money (Meera and Larbani, 2009). Basically, it is a set of double entry
operations.

Standard macroeconomic theory suggests that an increase in money supply would lower interest
rates and in turns encouraging more spending and consumption including lending and
borrowing. In the short term, the increase of money supply correlates to an increase in Gross
Domestic Products (GDP). Although the long-term effects are more difficult to predict, it is
generally believed that with the increase in money supply should result in rising economic
productivity and in turns increase the value of money in the circulation. This argument rests on
the implicit assumption that money is valuable as it has its economic worth or intrinsic value.
Money supply that rests on fiat money system runs a risk of being decoupled with economic
activity and easily loses its value. Therefore, we argue here that the increase in money supply
(fiat money with no economic worth i.e. no real asset backing) would not translate into a
proportionate rate of economic productivity (real GDP). We contend that the growth in money
supply would not translate into similar growth in economic productivity but instead the
excessive liquidity in the economy would put pressure on prices resulting in higher cost of living
over time.
Money supply that is not backed by underlying assets are bound to keep pressures on the
inflation. The argument can best be shown using the equation of exchange where;

M V = P Y
M = Quantity of Money
V = Velocity of Money in Circulation and
P = General Price Level (Inflation)
Y = Real Economic Output of Goods & Services

119
Availability of more money in circulation will keep pressure on inflation to rise and also will
bring the value of money to go down since the total assets (real economic output) of a country
have not changed. The rise in inflation and devaluation of money exert more pressures for the
cost of living to go up. Our priori is that in the absence of real assets backing to the money
supply, the real economic output would not be in tandem with the rise in money supply as there
are pressures for inflation and also assets price bubbles (see figure 1 below).

Figure 1: Relationship between Money Supply and Real Economy

Methodology
The study utilises secondary data to examine the trend and changes of increase in money supply
on real economic output and cost of living of a country. The relevant data for the study were
collected from published databases of the World Development Indicators (WDI 2019) of the
World Bank and International Monetary Fund (IMF) data outlook. This study covers three
major countries of South East Asia (SEA) namely Malaysia, Singapore and Thailand. The
selection of the countries was made in consideration of their geographical locations and
similarities in economic activities and development. The study covers the period of twenty
seven years (1990 2017) which captures the years of major economic crises faced by the
world and the sampled countries. The data collected with respect to money supply, economic
output and cost of living was analysed using graphical chart presentation to observe if the trend
and changes of the money supply has consequences or effects on the economic output and cost
of living in the sampled countries.

output is measured by the real GDP per capita (adjusted for inflation). We estimate total assets
of a country by adding net investment in non-financial assets, net investment in financial assets,
net foreign assets and total reserves of a country and scaled it by the number of people in the
country. Similarly, the cost of living is estimated by using the difference between money supply
and total assets of each country (see the earlier section for the rationale). With an assumption
that money supply will only affect the economic output one year after its issuance, the study
includes one period lag in its analysis for economic output. Although all of the variables only
crudely measure what they purported, it is considered sufficient to capture the essence or trend
of the relationship (if any).

Results and Discussion

This section discusses the analyses data on the consequences of an increase in money supply
on the real economic output, and cost of living. The latter variable is defined as the amount of

120
money needed to satisfy the level of wealth, comfort, material goods and necessities to an
individual living in a particular country.

Table 1: Descriptive Statistics of Average Total Assets, Money Supply, Real Economic
Output and Cost of Living in Malaysia, Singapore and Thailand (1990-2017)

Country/ Total Assets Money Real Econ Output Cost of Living

Average Supply
Malaysia 83,723.79 131,085.70 50,162.24 47,361.91
% 0.64 1.00 0.38 0.36
Singapore 90,411.92 107,149.60 25,360.12 16,737.68
% 0.84 1.00 0.24 0.16
Thailand 16,097.14 27,138.33 12,388.71 11,041.19
% 0.59 1.00 0.46 0.41
Note: Money in Local Currency Unit
Source: Data from World Economic Indicators Data (2019)

Table 1 displays the means of money in supply, total assets, real economic output and cost of
living over the period of twenty-seven years in the Malaysia, Singapore and Thailand. Cost of
living on the average takes 41% of the money supply in Thailand over the period discussed and
36% in Malaysia and only 16% in Singapore. On the same observation, Thailand managed to
translate 46% of its money supply into real economic output while Malaysia managed to do it
at 38% and Singapore at just 24%. The difference between the % of real economic output and
rowth for
Malaysia, 8% for Singapore and 5% for Thailand respectively.
The study contends that in the absence of real asset backing the fiat money, the issuance of
more fiat money in circulation would result in less productive economic activities. This should
translate into greatly different lines between the money supply and the productive economic
growth (real economic output). We tabulate the data to form graphical lines depicting the two
variables relationship over the twenty-seven-year period (1990-2017). The results are as
displayed in Figure 2 to 4 representing Malaysia, Singapore and Thailand respectively.

Trend of Money suppy, Real Economic Output and Cost of

60000 Living for Malaysia from 1990 to 2017

50000

40000
MONEY SUPPLY
30000
REAL ECON
20000
COST OF LIVING
10000

0
1 3 5 7 9 11 13 15 17 19 21 23 25 27
Figure 2: Trend of Money Supply, Real Economic Output and Cost of Living for
Malaysia

121
 Trend of Money suppy, Total Asset, Cost of Living, Economic
output and Standard of Living Singapore from 1990 to 2017
250000

200000

150000 MONEY SUPPLY

100000 REAL ECON

50000 COST OF LIVING

0
1 3 5 7 9 11 13 15 17 19 21 23 25 27
-50000

Figure 3: Trend of Money Supply, Real Economic Output and Cost of Living for
Singapore

All of these figures exhibit similar trends in that the growth of money supply and the real
economic output produce two different lines indicating that the increase in money supply does
not translate into similar growth for real economic output. Even though the real economic
output did increase over time, such an increase is way below the rate of growth for the money

money supply has not translated proportionately into the real economic output; resulting in the
cost of living to go up or bringing the value of currency lower than before.

Trend of Money suppy, Total Asset, Cost of Living, Economic

output and Standard of Living Thailand from 1990 to 2017
300000
250000
200000
MONEY SUPPLY
150000
REAL ECON
100000
COST OF LIVING
50000
0
1 3 5 7 9 11 13 15 17 19 21 23 25 27

Figure 4: The Trend in Money Supply, Real Economic Output and Cost of Living
for Thailand 1990-2017

One notable trend in Figures 2 to 4 is the rising cost of living for all the three countries as a
result of increase in money supply. Over the twenty-seven years, it is visible that all of the
people in these three countries were experiencing higher cost of living in order to keep the same
standard of living. Wage in the respective countries has risen over time but may not be
sufficient to keep up with the sharp rising cost of living particularly for people in Malaysia (see
Figure 2). The cost of living line in Malaysia is increasing at a faster rate than that of Singapore
and Thailand. The gap between the real economic output and the cost of living is higher and

122
more evident in the last six years for Malaysia, five years for Singapore and four years in
Thailand.

The effect of two economic crises namely the infamous 1997 Asian Financial Crisis and the
2008 Sub Prime crisis was felt by all of the three countries but with varying degrees. Malaysia
was hit hard by the Asian Financial Crisis resulting in higher cost of living and lower real
economic output for the year 1998 to 2002; whilst the effect of Sub Prime Crisis is moderate as
Malaysia shares quite significant portion of export to the US and Europe where the crisis hits
really hard. Singapore on the other hand, was sheltered from the Asian Financial Crisis but paid
its price in the form of increasing cost of living starting with the 2008 crisis. For Thailand, the
Asian Financial Crisis hit hardest its real economic output until about 2002 before it stabilised
again. The Sub Prime Crisis effect was not felt as bad but since then the cost of living in
Thailand has surged and since 2013 has gone beyond the real economic per capita.

Next we test the impact of increase in money supply on economic output using the statistical
analyses. If the increase in money supply is more than the corresponding increase in real
economic output, we should be seeing significant difference between the two when a paired t-
test is performed. We test the above contention using two different measures at level as well at
the rate of change. Results in Table 2 below shows that the above contention is founded. The
increase in money supply both at level and change year to year has more than exceeded the
matching economic output adjusted for inflation. The difference from year to year is very
significant and has led to increase in cost of living. When the money in circulation is more than
the value of its economic worth, the pressure is on living costs and the value of the currency
will worth less than what it was before.

Table 2: Paired t-test Relationship between Money Supply, Real Economic Output
and Cost of Living

Country Mean Std Error Std Deviation

Panel A: Money Supply and Real Economic Output (Level)
Malaysia 13785.4*** 2309.26 11999.28
Singapore 81375.3*** 8707.95 46078.16
Thailand 75471.2*** 11608.07 60317.30
Panel B: Money Supply and Cost of living (Level)
Malaysia 15786.3*** 1753.07 9109.22
Singapore 90411.9*** 6159.09 32590.85
Thailand 83723.8*** 12382.32 65521.08
Changes in Money Supply, Real Economic Output & Cost of Living
Country Mean Std Error Std Deviation
Panel C: Money Supply and Real Economic Output
Malaysia 1415.37*** 1814.44 988.01
Singapore 6052.03*** 8229.09 5503.35
Thailand 7506.42*** 9883.80 5885.93
Panel D: Money Supply and Cost of living
Malaysia 849.36** 418.42 2133.52
Singapore 3937.73*** 1093.17 5680.26
Thailand 6697.66*** 1765.30 9001.29
Source: Data from World Economic Indicators Data (2019)
*** Significant at 1% level ** Significant at 5% level * Significant at 10% level (one-tailed test)

123
Conclusion
In this study we set out to test the argument that the increase in money supply that has no real
asset backing, i.e. fiat money, is disconnected to the real economic growth. In turns, such an
increase in money supply is putting more pressure for the currency to devalue (worth less than
it was). More money in circulation without the corresponding increase in real assets would
result in devaluation of the currency and almost invariably causing the cost of living to rise
higher. We collected data for twenty-seven years for Malaysia, Singapore and Thailand over
the period of 1990 to 2017 to examine if the above contention is true. All of the analyses both
statistical and trend changes point to the same conclusion that the increase in money supply has
not translated or been reciprocated in terms of real economic output.

Increase in money supply among others is due to the ability of private banks to create more
money out of thin air. Werner (2014) provided an evidence that additional money can be created
by invariably almost every bank either private or publicly owned that has put pressures on the
economy to generate real economic output. Since fiat money has no real asset backing, the
absence of real economic productivity investment opportunities and misallocation of capital
that lead to speculative investments, means the increased supply of money would bring down
the value of money already in circulation and or push the price of goods and services higher
than what it was before the increase of money supply.

The presented evidence thus far has clearly demonstrated that the increase in fiat money supply
has limited impacts on the real economic output. Since the abolishment of the Brentton Wood
agreement in 1970 that removed the requirement of having money to be pegged to the price of
gold, almost every decade there will be one economic crash or crisis. During the crisis, the
overvalued money will be forced to come down to the level of real economic output to set
everything to be in the equilibrium again. In the process of readjusting, many people especially
the poor pay hefty prices of economic crisis as the value of money is re-set to its real worth to
compensate for the excess of liquidity in the market and in the process depriving the poor and
become even poorer. Given the present monetary system, it does not take long after the crisis
before the whole process of money creation would start again and benefit the rich at the top and

to the idea of changing the present monetary system?

References
Azizan, H. (2017, May 28). IIUM survey finds Malaysian mostly contented. The Star. Retrieved
from https:// www.thestar.com.my/news/nation/2017/05/28/iium-survey- finds-
malaysians-mostly-contented/
Chappelow, J. (2019, June 25). Money supply. Investopedia. Retrieved from
https://www.investopedia.com/terms/m/moneysupply.asp
Dwyer,G.P.Jr and Hafer R.W. (1999). Are money growth and inflation still related? Economic
Review - Federal Reserve Bank of Atlanta. 84(2),32-43.
Friedman, M. (1968). The role of monetary policy. American Economic Review, 58(1),1-17
Hahn, A. C. (1920). Volkswirtschaftliche theorie desbankkredits. J.C.B. Mohr, Tubingen.
Hexter, M. (1916). Implications of a Standard of Living. American Journal of Sociology, 22(2),
212-225. Retrieved from http://www.jstor.org/stable/2763822
High cost of living is No.1 issue, says Suan Dusit Poll (2018, February 11). Bangkok Post.
Retrieved from https://www. bangkokpost.com/thailand/general/1410591/high-cost-of-
living-on-top-of-10-issues-of-peoples-concerns-poll

124
 International Monetary Fund Data. Retrieved from
th
https://www.imf.org/external/pubs/ft/weo/2019/01/weodata/index.aspx on 20 June, 2019.
Liew, E. (2019, February 22). Budget 2019 discussion-3 things Singaporeans are concerned
about. MoneySmart. Retrieved from https://blog.moneysmart.sg/budgeting/singapore
budget-2019-comments/
Mcleod, H.D. (1905). The theory and practice of banking in 2 volumes. Longman, Greens and
Co., London.
McLeay, M., Radia, A. & Thomas, R. (2014). Money in the modern economy: An introduction.
Bank of England Quarterly Bulletin, Q1.
Meera, A. K. M. amd Larbani, M. (2009). Ownership effects of fractional reserve banking: An
Islamic perspective. Humanomics, 25(2), 101-16.
Mohamad Salleh, N. A. (2019, March 30). Indonesia votes: What are the hot-buttons issues for
the April 17 polls? The Straits Times. Retrieved from
https://www.straitstimes.com./asia/se-asia/indonesia-votes-what-are-the-hot-button-
ssues-for-the-april-17-polls
Ritter, J. (1995). The transition from barter to fiat money. The American Economic
Review, 85(1), 134-149. Retrieved from http://www.jstor.org/stable/2118000
Shumpeter, J.A. (1912). Die theorie der wirtschaftlichen entwicklung. Harvard University
Press, Boston.
Syed Jaemal Shah, SZ. (2018, September 2018). Sad truth about financial standing. The Star.
Retrieved from https://www.thestar.com.my/opinion/letters/2018/09/12/sad-truth-about-
financial-standing/
Soddy, F. (1934). The role of money. Elkin Mathews & Marrot, London.
Werner, R.A. (2014). How do banks create money, and why can other firms not do the same?
An explanation for the coexistence of lending and deposit-taking. International Review of
Financial Analysis, 36, 71-77
Werner, R.A. (2014)b. Can banks individually create money out of nothing? - The theories and
empirical evidence. International Review of Financial Analysis, 36, 1-19
World Development Indicators Databases. Retrieved from
https://datacatalog.worldbank.org/dataset/world-development-indicators on 24th June,
2019

125

View publication stats