Creation of money

2012

Content
1
 1. Introduction

2. History of the money creation

3. Fist paper money

4. Functions of the money

5. Development of the money

6. The banking system and money creation

7. Resources

1. Introduction

Money moves the World. Money is considered not only as a tool for trade but unfortunately
also as a tool for power and strength. In most of the countries we can see similar model of the

2
power as there was in the ancient times. The wealthiest person- the King reins and controls his
country. The modern version would be that the wealthiest people move the political or local
governmental scene and so even without a blue blood they became the modern nobility. But
how did these people gain their wealth? If we understand well the modern system of money
creation and banking we can easily keep earning from circulation of our money.

2. History of the money creation

Cash currency generally can be defined as goods which are in a company generally accepted
medium of exchange. An exchange between people has always existed naturally and at the
very beginning ran a so-called barter - kind exchange. Just one commodity for another, I'll
give you a bag of nuts, you gave me a knife.
Primarily people were exchanging goods in barter deals but then several problems appeared.
Local people didn´t have two goods of similar value which they could exchange. Second
problem was, as society grew and became anonymous, they had to be both ready to make the
trade at the same time, as the trust of the small group no longer existed. Due to these
limitations, people had to invent the mean of payment to continue in their trading. The first
type of money was created as a tool for goods exchange.

The most popular means of payment before the coins period were the kauri shells. The earliest
mention of its use date back 3500 years ago and comes from China. Stone discs were used for
payments under the social obligations and dispute settlement on the island of Yap in the
Pacific Ocean. Salt bars were widely used as currency in Ethiopia until the 20th century.

The first coins, which were pieces of precious metal, were carefully determined by their
appropriate fineness, weight and the sign or publisher was printed on one side. The first coins
developed in Lydia in the early 7th century before Christ. This money was excavated from a
natural alloy of gold and silver from Paktolos River.

The oldest European coins are considered minting of silver from the Greek island of Aigina
from the 6th century BC. Both of these types of coins did not have a typical shape that is
characteristic of later excavation, but had the shape of beans, since they were cast into drops
of precious metal which has been stamped by the publishers mark.

In periods from 5th to 3rd century BC coinage underwent a wide technical and artistic
development in Greece During the formation of the Roman Empire bigger plates made of raw
copper were stamped but they appeared as impractical to use, even if supplemented by a
number of smaller parts. For these reasons, sometime around 211 BC Romans switched to
silver coinage. These silver coins began to be called – denarius.
Around 50 BC, Rome began minting gold coins - aureus and from the year 309 Constantine I
introduced new coins called solidus. All these coins differed in the weight of the precious
metals. Excavation of Roman denarii was completed around the end of the first quarter of the
4th century, but then appears again as a nominal minted in Carolingian Europe, 8th and 9th

3
century. Gold solidus passed this period and greatly influenced early medieval Europe's
monetary system.

3. First paper money

When the coin system began to spread, people started to gather bigger amounts of coins to
secure their wealth. This led both to try to keep them safe, secondly, that their "wallet"
became very bulky and heavy. So they stored their treasures at the “safe” trades who finally
offered a solution - paper bills, representing the value of coins deposited with them. These
benefits of such securities were first used in China, where in the 11th century developed a
system of state issued banknotes.
In Europe, the paper currency appeared in 1661. The Stockholm bank began to issue paper
notes due to the lack of the silver coins. In 1695 the Norwegian merchant took an action from
the Swedish example. Thor Jorgen Mohlen sent the first time in their country banknotes in
circulation. Scottish economist John Law believed that money is purely a medium of
exchange, so that they may not have to have their own value. Scotland saw the first bills in
1716. Law then brought the idea of paper money to France. In 1718 John Law founded the
French bank which then received permission from Louis XV to issue banknotes. But
economists were suspicious about the notes without their own value and when they bank
printed too much, the notes have become worthless because the value of something can only
be attributed to people and they were not interested in endless wealth in the form of paper.
This extreme situation also contributed to the French Revolution.

“In the 16th and 17th century in England, the goldsmiths were an occupation that often
evolved into bankers. Other merchants needed places to temporarily store large amounts of
gold, and they chose to store them with the goldsmiths because the goldsmiths had the best
security systems of the day. When merchants stored gold, the goldsmith would give them a
statement indicating how much gold the merchant had deposited. Once merchants began to
store gold, paper money developed rapidly. When a merchant wanted to buy something, he
could return to the goldsmith and reclaim his gold, or he could sign over the statement he had
from the goldsmith to someone else and let that person collect the gold. Because the second
option was popular, the goldsmiths innovated and issued statements made out not to a specific
person, but to the bearer, whoever presented the statement to the goldsmith could collect the
gold. At this point the statement issued by the goldsmith was money because it was something
with which people bought things. The invention of paper money was successful because for
some purposes it had more desirable qualities as money than gold or silver had.” 1 As the new
bankers became more experienced, they found out that they can make a great business out of
storing the precious metals. They became to trade with the paper bills and metals and charged
the little interest for their services. Later on the paper money was no longer 100% backed by
gold. It was still partially backed by gold in goldsmiths vault, and partially by other people's
promises to pay him in gold.

4
“Although the bank created money, it was limited by the possibility that holders of the paper
would bring in the paper and demand gold. To maintain the ability to pay off the paper
money, banks held reserves of gold, and they needed larger amounts of gold as they issued
more paper money. There was no fixed ratio of gold to paper money, but rather the ratio
depended on the optimism or pessimism of the bankers. When bankers were optimistic and
times were good, they would issue more paper for each pound of gold than when they were
pessimistic and worried about redemptions of paper money that they issued.” 1

4. Functions of the money

Money market economy performs three important functions: First is the medium of exchange
based on the ability to mediate the exchange of money and the instruments is based on the
willingness of businesses to accept them for payment obligations. This fulfils both the role of
currency (banknotes, coins), both bank money, which is money in the bank on the accounts or
deposits in savings banks. With the development of monetary and banking system, increasing
the share of cashless payment and reduces the share of currency in exchange acts.
Second function is the billing unit. It is the ability to act as a measure of money value of all
other goods and services, assets and liabilities. This function is becoming a tool for comparing
the money value of goods and services. This makes it possible aggregation, and testing
different economic variables.
Third function is to store of the value of money over time. We do not spend money only on
direct purchases of goods and services; we can also defer purchases made later. Ability to
function as a store of money values, however, strongly depends on the stability of their
values. In the face of growing inflation, the ability of money to fulfil this function worsens
and the economy tends to replace the money in this capacity in other assets (gold, artwork,
real estate...)

5. Development of money

First of all we have commodity money. Money as a medium of exchange has historically
appeared first in the form of commodities (cattle, oil, wine, copper, iron, etc.). Today is
known as barter exchange. Even these days we can sometimes see the barter trade in services
or between friends etc.
Second type of money is paper money which were created to buy and sell more effectively
and to preserve the value for later purchases.
Third type of the money is bank money which represents a modern form of imaginary money.
But how do the banks create money?

5
 6. The banking system and money creation

Today the banking system is responsible for money creation in the world. The banking system
consists of commercial banks and the central banks.
Commercial banks are private companies which trade with money. They receive deposits
from the savings groups and then they forward part of this money to people or companies
with investment opportunities. In both cases, the money paid for a transaction fee is in the
form of interest. The first commercial bank pays interest to the person who loaned her money.
Then the borrower pays the interest to the bank. The difference between the second and the
first interest is the profit of the bank. Bank profit is a reward in this case for the mediation of
money.
The central bank is a “mother” of commercial banks. Commercial banks deposit their money
with it and if they need so, they can easily borrow as well. In both cases, there is trade with
money in return for payment again in the form of interest. The Central Bank provides
commercial licenses to new banks, to oversee their activities, draws and emits the new coins
and banknotes.

The commercial banks operate with two main types of assets- the loans and government
securities that earn interest. Both securities and loans are debt owed to the bank. Loans are
usually debt contracts that the bank has negotiated directly with the borrower, while securities
are debt contracts that the bank buys without negotiating the terms. The bank has other assets,
such as deposits at the central bank and paper money held in its vaults. In the past these
assets earned no interest and there was a cost-foregone interest to holding these non-interest
bearing assets. A bank must hold some because it must stand ready to pay depositors who
want to exchange deposits for cash. However, modern banks have another reason to hold
these assets. Governments, usually acting through their central banks, have laws and
regulations that establish the amount of these assets that a bank must have. We call these
required assets legal reserves which are set by the Central Bank.

“The idea of banks creating money sounds strange to someone who thinks of money as gold
or silver. However, for several centuries now most money has been in the form of bank debt.
When one sees the creation and destruction of money as the creation and destruction of bank
debt, the process is less mysterious. Thus, money creation is a side-effect of banking.“ 1

6
7. Resources

1
 Cyber Economics, http://ingrimayne.com/econ/Banking/Overview10ma.html,
14/3/2012
 Vantange Quest, http://www.vantagequest.org/trees/money.htm#.T3tStXpRGSo,
14/3/2012
 Studentské, http://ekonomie-otazky.studentske.cz/2010/05/4-vznik-penez.html,
8/4/2012
 Národy, http://narody.ic.cz/index.php?a=47, 8/4/2012
 P-numismatika, http://p-numismatika.cz/index.php?get=kapitola4, 8/4/2012
 Základy bankovnictví, Kalabis, Zbyněk, Bizbooks, 2012