I am writing this post since most of us are interested in money. When I was in 7th grade, I had this huge doubt. If it is government’s job to print money, then why can’t it print more money and give it to people to solve all the problems. I even believed, government is too lazy to print and distribute more currency notes :) . I asked this doubt to my parents and teachers. But at that time, I was unable to get it clearly. Years later, when I surfed internet, I have seen, it is very common question for many people. So I referred few sites and got some understanding. By the way I am sharing it with you .
What is Money?
A Money is just a promise by the central/Reserve bank of the country to pay you a particular amount if you produce the note to them. The real value is usually in the material stuff like food, precious metals, on the basis of which those ‘promises’ are made. So a country can make promises as it’s like and to as many people as it want. But why just printing a lot of money does not makes everyone rich?
Why printing more money cannot make everyone rich?
To understand this, I came up this small story. There was a farmer. He had 10 sons and owned a land.All the sons worked hard and managed to produce 10 kgs of rice daily (for simplicity just imagine rice is produced daily ). Now the farmer, instead of giving each son 1 Kg of rice directly, he decided to give 30 signed coupon monthly upon completion of their work. So they can exchange one coupon daily for 1 Kg of rice per day. Days passed. After few years, all the sons got married. Now they were 20 including their wives. Automatically demand for rice increased. Now if the sons asked their father something like, “Father, give us 60 signed coupon per month so that we can buy 2 kgs of rice per day for our family” , then it is reflection of their ignorance. Because the total rice produced by them is still 10 kgs per day. Even though, their father gave them 60 coupons, the demand for rice will increase and finally they will get the same 1 kg rice for 2 coupons. The actual solution here is they need to produce more rice based on their current needs, not by giving more coupons. In real world it is very much complicated. Farmer is government(central bank/Reserve bank), sons and their wives are people and rice is resources like food, raw materials, infrastructure., etc. This story gives the reason for the question “why printing more money cannot make everyone rich?” Now if you print more money than what your wealth is actually worth, the total wealth being constant, the VALUE of those notes decreases. So it is Central/Reserve banks job to monitor the need of currency based on resources and print , release money based on that. For example in India, at end-March 2016, the value of total banknotes in circulation was ₹16,415 billion and it is increased by 14.9% over last year. Please refere the below link of Reserve Bank of India for more details.
https://www.rbi.org.in/scripts/AnnualReportPublications.aspx?Id=1181
How is new money released into the economy?
Now arises a question, when the government prints the new money, whom does it go to first and in exchange of what? In most of the country, it is based on Fractional-reserve banking. Fractional-reserve banking is the practice whereby a bank accepts deposits, makes loans or investments, and holds reserves that are equivalent to a fraction of its deposit liabilities. Reserves are held at the bank as currency, or as deposits in the bank’s accounts at the central bank. In simple words, Money is created as debt, when somebody borrows in bank in an exchange for a promise to pay it back. Banks take loan from Reserve Banks or Central Banks, and money is created as well as circulated.If you need more details about this process, you can refer it here.
The origin of this system goes back to the Middle Ages. It is the true story of the goldsmiths who became bankers later. The goldsmiths of seventeenth-century, London developed banking in its modern form. In those middle ages,money and coins was not used very much by people. But the kings and the big merchants owned gold,and used it to finance their needs. But during wars and robberies these golds fell into the hands of pillagers.At that time they used to give it goldsmith for keeping it safe. The goldsmith received the gold, gave a receipt to the depositor, and took care of the gold and ofcource he charged a fee for this service.In short, little by little he managed to do his buissness across all country.One fine morning a friend of him,visited and asked a favour. He needed some gold to settle a transaction. But Goldsmith was not interested in giving him gold directly. But he got an idea to give him a receipt just like he deposited gold with him and asked his friend to exchange the receipt somewhere. And just now goldsmith created a new money. Day by day,the goldsmiths maintained a running account of each depositor’s holdings. He also conducted a profitable business loaning out depositors’ gold, silver, and coins to government and private customers. To meet the demands from borrowers, goldsmiths turned to paying interest on deposits and offering time deposits. This laid the foundation for important innovations in banking and origin of current banking systems.