Money and Banking

All values in the economic system are measured in terms of money. Our goods and services are sold for money, and that money is in turn exchanged for other goods and services. Coins are adequate for small transactions, while paper notes are used for general business. There is additionally a wider sense of the word ‘MONEY’, covering anything which is used as a means of exchange, whatever form it may take. Originally, a valuable metal (gold, silver or copper) served as a constant store of value, and even today the American dollar is technically “backed” by the store of gold which the US government maintains. Because gold has been universally regarded as a very valuable metal, national currencies were for many years judged in terms of the so-called “gold standard”.

Nowadays however valuable metal has generally been replaced by paper notes. National currencies are considered to be as strong as the national economies which support them. Paper notes are issued by governments and authorized banks, and are known as “legal tender”. Other arrangements such as cheque and money orders are not legal tender. They perform the function of substitute money and are known as “instruments of credit”. Credit is offered only when creditors believe that they have a good chance of obtaining legal tender when they present such instruments at a bank or other authorized institution. If a man’s assets are known to be considerable, then his credit will be good. If his are in doubt, then it may be difficult for him to obtain large sums of credit or even to pay for goods with a Cheque.

The value of money is basically its value as a medium of exchange, or, as economists put it, its “purchasing power”. This purchasing power is dependent on supply and demand. The demand for money is reckonable as the quantity needed to effect business transactions. An increase in business requires an increase in the amount of money coming into general circulation. But the demands related not only to the quantity of business but also to the rapidity with which the business is done. The supply of money, on the other hand, is the actual amount in notes and coins available for business purposes. If too much money is available, its value decreases and it does not buy as much as it did, say, 5 years earlier. This condition is known as “inflation”.

Banks are closely concerned with the flow of money into and out of the economy. They often co-operate with governments in efforts to stabilize economies and to prevent inflation. They are specialists in the business of providing capital, and in allocating funds on credit. Banks originated as places to which people took their valuables for safekeeping, but today the great banks of the world have many functions in addition to acting as guarantees of valuable private possessions.

Banks normally receive money from their customers in two distinct forms: on current account and on deposit account. With a current account, a customer can issue personal cheque. No interest is paid by the bank on this type of account. With a deposit account, however the customer undertakes to leave his money in the bank for a minimum specified period of time. Interest is paid on this money.

The bank in turn lends the deposited money to customers who need capital. This activity earns interest for the bank, and in this interest is almost always at a higher rte than any interest which the bank pays to its depositors. In this way the bank makes its main profits.

We can say that the primary function of a bank today is to act as an intermediary between depositors who wish to make interest on their savings, and borrowers who wish to obtain capital. The bank is a reservoir of loan able money, with streams of money flowing in and out. For this reason, economists and financiers often talk of money being “liquid”, or the “liquidity” of money. Many small sums which might not otherwise be used as capital are rendered useful simply because the bank acts as a reservoir.

The system of banking rests upon a basis of trust. Innumerable acts of trust build up the system of which bankers, depositors and borrowers are part. They all agree to behave in certain predictable ways in relation to each other, in relation to the rapid fluctuations of credit and debit. Consequently, business can be done and cheque can be written without any legal tender visibly changing hands.