Sunday, May 13, 2012

Where is the Money?


So finally writing for this blog after a long time, been busy in non-creative though essential chores. In anycase would try to get frequent again with my blog entries. Even though I didn’t write for the blog, I wrote a few articles that have been published over the past few months and I have posted those below.

Also I am going to post my entire blog to my new site www.randomchalice.com pretty soon. It’s my company site which would have some other content as well apart from the blog articles. There I have added a section “Blog” which would have this blog site and other articles as well as twitter feed updates on some important events across the world.

During this year I have thought of covering extensively on the following three topics:
-        -   Monetary System
-          - Financial Derivatives
-          - Statistics

It will not be as boring as it sounds as I would try to link them to everyone’s daily lives; you would be surprised how especially things like financial derivatives and statistics effect you even though you may not be using them directly. For today let me start with our Monetary System. So here we go….

Sometime back on one my travels, I had a rude awakening, my co-passenger on the flight was a person who has been working in a big private sector (foreign) bank for more than a decade. However I was shocked to see how flimsy was his knowledge of our monetary system and in particular the role of the banks.

So let me ask you a simple question: Let’s say you go to a bank for a loan to start some project, the bank is happy with your project plan and decides to lend you the money. My question is from where does the bank get that money?

If your answer is that it lends the money that depositors give to the bank, I would say join the line of the many that think the same way. This is grossly WRONG!!! This understanding I believe emanates from the period when we used to have commodity based money and like everywhere updating knowledge in Universities is wishful thinking.

The correct answer is that the banks “simply print it out of thin air”. To clarify further, let me ask you this question, let’s assume the start of our paper money system, no one has yet asked for a loan then from where do the depositors get the money to deposit for the banks to then lend?

I hope you get the point, the banks create money out of thin air which it lends out to you, you deposit part of that money to your savings account with that bank (let’s keep it simple for now) and some you give to suppliers, as salaries etc. which are again transferred to the respective saving accounts of those people.

Now if you are thinking what about the governments don’t they create money? Yes they do however there is a difference between money created by government and that created by bank. The government or in today’s chicanery terminology the Central Banks create money what we called as high powered money. This money is transferred to the accounts that the banks maintain with the Central Banks. This high powered money is not what is loaned out, this money moves out of the banking system in only three ways:
  •         Through taxation, as the citizens pay taxes to the government, the banks transfer this high powered money  to the government account again maintained with the Central Bank
  •         The debt the government sells
  •          When you physically withdraw cash from your ATMS, so yes your cash is part of that high powered money.


You may be wondering then what is the use of this high powered money, well even though this component of the money supply is very small, but the government and Central Bank can influence the amount of credit that flows into the system by tweaking around this high powered money.

So remember in this fiat money world:
-          A loan or a credit taken from a bank is printed by the bank out of thin air
-          This credit in turn leads to savings and not the traditional thinking that savings lead to credit
-          This credit plus the high powered money is our total money supply in the system
-          And the most important thing, this system is a giant Ponzi scheme which can only work if we continue to take more and more credit!!!

How is that possible, I know apart from this question there would be many other questions in your minds, would continue with this topic in my next article………….

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