The Basics of Money and Banking
For the economy to exist, there has to be a medium of exchange. This medium should allow the exchange of goods and provision of services. At the same time, it has to be common and needs to have its own value. In the past, our ancestors directly traded their goods and services with each other. For example, wheat farmers used to trade their surplus wheat produce for other goods and services. This form of exchange is called bartering. Now let’s learn more about Money and Banking
Suppose a shoemaker wants to trade his shoes to buy some rice. He would have to search for someone who not only wants to sell rice but also wants shoes in return. Basically, both parties have to agree to buy and sell each other’s commodities.
This century-old practice has a few unique advantages:
- The amount of flexibility that comes with bartering is mind-blowing. Not only related products such as strawberries and raspberries but even headphones and refrigerators can be traded.
- Bartering also allows for trading in services. For example, a painter can paint a farmer’s house in exchange for a few kilograms of wheat.
Although bartering was in practice for centuries, it still has a bunch of flaws.
Introducing a medium of exchange:
In a society where money exists, a consumer simply trades in money for the desired product. This way, there is no need to search for a person who wants to make the ideal trade. Money issued by a national government is termed the national currency. This money is issued on the behalf of a central bank, which has the power to print the nation’s fiat currency.
Other than coins and paper notes, a nation’s currency may also be in the form of checks, money orders, and even digital cash. All currencies have a perceived value and can be exchanged for other objects or commodities that are for sale. However, as each nation has its own currency, commodities of one nation cannot be bought with the currency of another.
Similarly, the law dictates that no seller of a nation can refuse the national currency in exchange for the goods being sold. But as each currency has value, it can be exchanged for another nation’s currency, to make a purchase. Other than being restricted to a particular nation, the value of a currency and its existence in the market solely depends on the issuer. If the issuer or the central bank makes a terrible mistake, the value of the currency will plummet.
The magical storage closets
Storing all wealth in cold hard cash is no wise decision in this modern-day and age. So, to store each and every individual’s and company’s wealth, there are multiple storage closets available. These magical storage closets are known as banks! Each and every law-abiding citizen has most of their wealth deposited in their bank accounts. Those who deposited their money, also have the right to withdraw it from a nearby ATM (Automated teller machine).
This begs the question, “why to trust a bank, instead of storing wealth at home?”. Along with keeping money safe, banks also allow the government to easily find or collect taxes from its citizens. On the other hand, consumers also receive interest on the money deposited, so that they can grow their wealth at a faster rate than inflation. Interest rates depend on the economic situation, as well as the bank itself.
Different banks charge different interest rates, but it remains more or less similar. Banks also allow their customers to transfer money in the form of checks. This way, anyone can make transactions without carrying any paper notes or coins.
Just like other businesses, banks also exist to make a profit. But how does that profit earn while providing so many features? It’s simple, banks are only allowed to keep 10% of the money deposited as reserves. The rest is handed out in the form of loans, and the bank collects interest from the money handed out. However, if the depositor wants to withdraw his/her money, then the money deposited by the borrowers is used. This system works wonders because even the borrowers have their own savings, and there are tremendous in number. Here, the bank is the creditor and the borrowers are debtors, who eventually pay their debt with interest.
Usually, banks don’t lend money to poor individuals who have no assets or stable jobs. However, lending money to various poor households as one big loan may solve this problem. Professor Muhammad Yunus, the founder of Graham bank explains it better:
“If credit can be made available to the poor people on terms and conditions that are appropriate reasonable these millions of small people with their millions of small pursuits can add up to create the biggest development wonder”
Essentially, more money equals more purchasing power. This is one of the reasons why banks have different types of accounts and deposits. If the customer wants a higher interest from their deposit, they can open a fixed deposit. The money in an FD cannot be withdrawn until the fixed time period is over. However, this depends as some banks do allow their customers to break their fixed deposit and get their money back. Another type of bank account is the savings account. Savings accounts typically provide low-interest rates but allow the depositors to withdraw their money a few times.
Many individuals pass out of universities without knowing much about money and banking. I hope this article was able to explain the subject of banking and money in a nutshell.
One book that I would recommend to anyone who wants to learn more about this topic is:
If more students are trapped in debt, the next generation won’t be able to afford necessities, let alone services and lifestyle products. This would also contribute to the slowing down of the economy, as employers would find it difficult to find capable employees. Disguised employment in the economy would also increase and debtors would take to the streets. Violence would also be a matter of concern in the long run.