Money

Money is any marketable good or token used by a society as a store of value, a medium of exchange, and a unit of account. Since the needs arise naturally, societies organically create a money object when none exists. In other cases, a central authority creates a money object; this is more frequently the case in modern societies with paper money.

Money supply

Main article: Money supply

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The money supply is the amount of money available within a specific economy available for purchasing goods or services. The supply is usually considered as four escalating categories M0, M1, M2 and M3. The categories grow in size with M3 representing all forms of money (including credit) and M0 being just base money (coins, bills, and central bank deposits). M0 is also money that can satisfy private banks' reserve requirements. In the United States, the Federal Reserve is responsible for controlling the money supply (monetary policy).

Related Topics:
United State - Federal Reserve - Monetary policy

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Growing the money supply

Historically money was a metal (gold, silver, etc,) or other object that was difficult to duplicate, but easy to transport and divide. Later it consisted of paper notes, now issued by all modern governments. With the rise of modern industrial capitalism it has gone through several phases including but not limited to:

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• Bank notes - paper issued by banks as an interest-bearing loan. (These were common in the 19th century but not seen anymore.)
• Paper notes, coins with varying amounts of precious metal (usually called legal tender) issued by various governments. There is also a near-money in the form of interest bearing bonds issued by governments with solid credit ratings.
• Bank credit through the creation of chequable deposits in the granting of various loans to business, government and individuals. (It is critical that we understand that when a bank makes a loan, that is new money and when a loan is paid off that money is destroyed. Only the interest paid on it remains.)

Thus, all debt denominated in dollars -- mortgages, money markets, credit card debt, travelers checks -- is money. However, the creation of dollar-denominated debt (or any generic obligation) only creates money when a financial institution is granting the debt. Thus money is the medium of exchange and unit of account.

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Shrinking the money supply (M3)

Perhaps the most obvious way money can be destroyed is if paper bills are burned or taken out of circulation by the central bank. But, it should be remembered that legal tender usually constitutes less than 4% of the broad money supply.

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Another way money can be destroyed is when any bank loan is paid off or defaulted upon or any government bond is redeemed the money value of the contract or bond is destroyed — taken out of circulation.

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Money can be destroyed if savers withdraw funds from a bank, in which case that money can no longer be used for lending. Bank savings are actually a kind of loans — savers loan their money to a bank at a low interest rate or merely in exchange for the benefit of convenience or its security (accepting that they lose a small amount of value to inflation). The bank then uses this loan to loan to other people, at a higher rate of interest (so it can make a profit). When this happens the money exists in two (or more) places at once, and so the money supply increases. When a saver withdraws money, the loan is "paid off" and it can no longer exist in more than one place at once, and this "double money" disappears.

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In extreme forms, a bank run or panic may drive a bank into insolvency and, if uninsured, the savings of all its depositors are lost. Such bank failures were a major cause of the tremendous contraction in the money supply that occurred during the Great Depression, particularly in the United States. In that country many banking reforms were subsequently enacted during the New Deal, including the creation of the Federal Deposit Insurance Corporation to guarantee private bank deposits.

Related Topics:
Bank run - Insolvency - Deposit - Great Depression - Banking reforms - New Deal - Federal Deposit Insurance Corporation

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