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Money, money, money, from where it comes from?


While listening to the major players of world economy gathering in Davos, they all speak about the markets, how they function, what risk they can see in them, etc. But if you ask yourself what markets they are speaking about, you realise, those are financial markets. No-one speaks about vegetable market, fruit market, meat market, machinery markets, cement market, brick market, etc. These products seems need no market at all, and definitely not their attention. Yet the price of these commodities is decided somehow. After all the consumers and suppliers who meet in the supermarkets or on the internet find their way to make a deal of purchase -sell, without to consult it with all those clever bankers, financial managers and advisers.

I live in a medieval town, where all the squares used to be markets, and still they carry their names according to merchandise they used to sell there. You have, fruit market square, coal market square, horse market square, of course animal market square, etc. No square is called financial market, option market, futures, securities, bonds, shares, not even stock exchange market. I wonder, those people of medieval or even renaissance or baroque times, who left after them so many beautiful buildings, how they lived without all these?

If you follow all the participants of panels in Davos, you come to the conclusion that money is the most important commodity to sustain life. And yet, if i recollect correctly, except Marx, no-one speaks about money as commodity. So what is money? Why is it so important? They say money is debt. What does it mean? What is debt? Or should I ask what is financial debt? After all we are not speaking about debt in form of favour someone have done to you and you own him!

Financial debt is an agreement between lender and borrower, while both have certain expectation from the act of lending-borrowing. The lender expects, that the loan will be returned with certain additional value to the principal value the money was lent. The borrower expects, that the money borrowed to him will help him to overcome certain temporary difficulty, or to create certain activity, that will enable him in the future to generate enough income to return the loan with additional payment of interest as agreed, and eventually some leftovers will make him accumulate additional wealth, that otherwise he wouldn’t be able to accumulate.

This is an easy concept. But then many times happens, that the borrowers plans didn’t work out, and he has no funds to repay the debt. This is the risk the lender takes, against securing in the future income additional to principal of the loan he gave. To reduce this risk the lender turns to the expert on risk, the bankers, to manage his money, accumulated out of his activities in the past. And here we start the story of financial markets.

Let us start with short introduction to banking and money for beginners :

When someone puts money in the bank, and the bank uses the same money to give loan, and this loan is also deposited in the bank, the bank can give it again as a loan and so to infinite, and this is not good, because what if the first borrower and the first lender come in the same moment to withdraw the money? It becomes a problem. After all the bank got only once real money, the rest came from the same money it gave as loan.

But then, from where came money at first? After all it has to have some origin. Of course it comes from the government. Kings from the ancient times, until quite recently had only one task in the society, to fight wars and to collect taxes or protection to be able to pay to his soldiers. From where they got the money to pay the soldiers? After all the kings never created something useful to sell it on the markets. It is under their honor as sovereigns to do useful thing. Who will respect a king, who would cultivate food? Noone. Their task is to collect taxes and to make wars. But it is hard to collect taxes in the form of products, goods and merchandise, so they discovered coins, their cost was much lower than their face value. This they achieved by making the coins deficient. How? By making monopoly on the metal mines they used to mint the coins. Of course they had even then to fight the forgery, this is why the kings chopped minters hands, or even worse their heads. But maybe the most extreme act of defending the coin value has done by Henri king of England, who as response to complaints of the soldiers about the fake coins they were paid with, not only cut the right hands of all the king’s minters, but also castrated them. The modern response to currency forgery is not as cruel, but also harsh. Even if in today’s world, the cash money is small fraction of the money existing in the economy. Most of it is in form of savings, some freely exchanged on financial markets, like government or corporate securities, and some fixed in deposits.

Only small fraction of Money, about one trillion US Dollars is in form of cash. Large part of it is hold by foreigners, mainly in countries with unstable local currency. Narrow money M1 that includes liquid bank deposits is less than 4 trillion US Dollars as compared to broad money, including long term bank deposits, M2, that is about 14 trillion US Dollars.

So what all these data mean? If the financial system is at risk, from where it is expected to come?

Money has two functions, the first is means of exchange, second instrument to hold value. Both functions need faith of the public in stability in the value of the currency. The government have power to enforce usage of the local currency, by demanding tax payments in it. This is a strong argument for the local currency, since in most of the developed countries the taxes are usually 35% of the economy, except in the US, where there taxes are 25%. Not surprisingly, the public services and the public infrastructure in the US is neglected, if compared to Europe.

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