Money history, its importance and Control of money supply

Money:
Money has been a cornerstone of human civilization and economic development since ancient
times. From simple bartering systems to the rise of digital currencies and crypto currencies, the
evolution of money has been a fascinating journey. Money serves as a medium of exchange, a
store of value, and a unit of account. It has taken various forms over the years, from coins and
paper currency to virtual currency and digital assets. Today, our money is predominantly digital,
a shared construct created by society to enable trade and value creation. But at its core, money's
worth depends on trust and faith in the system

History of money:
Barter and Commodity Money:
Before the concept of money existed, People used the barter system, which involves the direct
swapping of goods and services. For example, a man giving a woman a basket that he wove from
scratch in exchange for a fish that he caught minutes earlier. Despite looking like an efficient way
to exchange goods, barter had its shortcomings. It needed a mutual convenience where both
required what the other side could provide. Also, valuation of non-similar goods was another
problem faced during the exercise.
Later, societies started using commodity money – items that were useful, and accepted in exchange
for goods and services. Three popular products included were salt, grains, and livestock. These
commodities were easily divisible, portable and could be stored unlike having to barter a basket
every time one needed fish. An early example of the above system was observed in around 3000
BC when the Mesopotamian shekel, a unit of weight based on barley grains originated.

The Rise and Spread of Metal Money:

The limitations of bulky commodity money led to the invention of coinage, a pivotal moment in
economic history. First, Cheap metals like copper and tin were used as standard of value. But there
was need of standard weight and purity of those metal, so a stamp was used to provide guarantee
about the weight and purity. Second, Precious Metal The next form of money was the use of some
precious metals such as gold, silver as a medium of exchange. The ratio of one metal to other was
declared by the state. The age of precious metals has been ended after two world wars. Thirds,
metal was made into coins of pre- determined weight.

The first metal coins date back to the 7th century BCE in Lydia (modern Turkey) and China. In
China, metal coins were made of bronze and shaped like farming tools. In Lydia, coins were made
of an alloy of gold and silver called electrum. Lydian staters were the first coins to be officially
issued by a government body. Early iterations of coins were also used by ancient Greeks, starting
in the late 7th century BC. These coins offered several advantages: divisibility (easily broken into

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smaller denominations), durability, and portability. Some coins had an
intrinsic value (value in themselves), which was reflected in their face value
these coins were also known as full bodied coins. As the price of gold began
to rise, then Government mix copper and silver in gold coins because the gold
was becoming scarce and expansive with the passage of time.

Paper Money and Banking Systems

Figure 1: First metal coin
Although metal coins were used for many centuries, people carried small
amounts of metal for trade. The need to carry large amounts of metal led to the use of paper money.
The first paper money was used in China during the Tang Dynasty (618-907 CE) and evolved
during the Song Dynasty (960-1279 CE). These early paper notes were promises to pay a certain
amount of precious metal, such as gold or silver, to the bearer on demand. This demand note system
required trust and stability from the notes issuing authorities. The paper money idea spread to the
Middle East and Europe. During the 17th century, European merchants and governments used
promissory notes and bills of exchange that provided the foundation for the modern system of
banking. As banks were established, such as the Bank of England in 1694, the issuance of paper
money and creation of national currencies became more formalized. The banks would maintain
reserves of precious metals and issue bank notes that could be exchanged for precious metal
reserves held by the bank. This system ensured the value of the bank notes in exchange for the
precious metals.In the United States, a national bank began with a plan by Alexander Hamilton,
the first Secretary of State. He thought a national bank would help stabilize the nation’s credit. The
first bank in the U.S., The Bank of the United States, was established in 1791.

The Gold Standard and Fiat Money

Many countries adopted the gold standard during the 19th century. In 1816, gold became the
standard of value in England. Each bank note represented a certain amount of gold, so only a
limited number of bank notes could be printed. This gave previously unbacked currency some
semblance of value and stability. By 1900, the United States had followed suit with the Gold
Standard Act. While the gold standard would slowly fade out of usage by the 1970s, the gold
standard played an important role in the history of U.S. money. The outbreak of World War I and
the subsequent economic downturn led to several countries going default on the gold standard.
Most currencies in the 20th century were of the fiat money type. Fiat money is a monetary base
that has no other utility than that which the government imposes on it and the faith of people in it.
It is not convertible into any precious material. Rather, fiat money derives its value from the
country’s stability and the economic strength it represents.

Modern-day money:

Along with paper money and coins, modern-day money has also branched out to include credit
and debit cards, online payments and crypto currency. When it comes to convenience, credit cards
and debit cards may be some of the most popular choices.

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  Credit cards allow lenders to set a credit limit on your card, so you can spend up to a
certain amount before you have to start paying it back to continue using your card. The
history of credit cards in America goes back to the 1950s when Diners Club issued the first
charge cards.
 A debit card, on the other hand, holds a set amount of money from your bank account,
which decreases with each purchase you make. Debit cards did not make their debut in
America until after credit cards. Some point to the Bank of Delaware’s debit card pilot
program in 1966 as the first time debit cards were used in America.

The internet has completely changed the financial world. It has brought about online banking,
electronic funds transfers, and digital payment systems, revolutionizing the way we handle money.
In the 21st century, we witnessed the rise of cryptocurrencies, which can be seen as the newest
form of money. Bitcoin, introduced back in 2009 by a mysterious person called Satoshi Nakamoto,
was the very first decentralized cryptocurrency. It operates on something called blockchain
technology, which is basically a decentralized ledger that keeps track of all transactions across a
network of computers. The cool thing about cryptocurrencies is that they offer secure and
anonymous transactions, which has sparked a lot of interest in the idea of decentralized financial
systems. Crypto currencies can be pretty volatile and there are some regulatory challenges
surrounding them. But despite that, they have gained a lot of popularity and have even influenced
the development of central bank digital currencies (CBDCs). Basically, governments and financial
institutions are looking into creating digital versions of their national currencies. They want to
improve payment systems and make sure they can still control the money in this digital age.

Figure 2: History of money from battering to digital currency

Importance of Money:

1. Basic Needs: Money helps us meet our basic needs, such as food, shelter, clothing, and
healthcare.

2. Financial Security: Having enough money provides financial security, reducing stress and
anxiety about the future.

3. Comfort and Luxury: Money allows us to enjoy comforts and luxuries, making life more
enjoyable and fulfilling.

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4. Freedom and Independence: Money gives us the freedom to make choices and pursue our
goals, enabling us to live life on our own terms.

5. Opportunities and Experiences:

Money provides access to education, travel, and new experiences, broadening our horizons and
personal growth.

6. Social Status: Money can influence social status, allowing us to participate in social activities
and maintain a certain standard of living.

7. Savings and Investment: Money enables us to save for the future, invest in assets, and build
wealth.

8. Charitable Giving: Money allows us to support causes we care about, making a positive
impact on the world.

9. Time and Energy: Money can save us time and energy by outsourcing tasks, allowing us to
focus on what matters most.

10. Peace of Mind: Having enough money can bring peace of mind, reducing financial worries
and enabling us to live a more relaxed life.

Figure 3: Money

Control Supply of Money:

The money supply is the total amount of cash and cash equivalents, such as savings account
balances, circulating in an economy at a given point in time. Controlling the supply of money in
an economy is one of the most important tasks that directly affect many aspects of an economy
including stability, inflation, interest rates and economic growth. This process, known as monetary
policy is a general strategy adopted by a nation’s central bank and can be defined as the
manipulation of a country’s money supply.

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Mechanisms of Monetary Control:
1. Central Banks and Monetary Policy
 Central Banks: Such central banks as the Federal Reserve System in the United States,
European Central Bank, and Bank of Japan are designed to facilitate the execution of
monetary policy.
 Monetary Policy: Refers to the measures that a central bank takes in order to control the
amount of money supply and price of money and credit with the purpose of accomplishing
the objectives of a nation’s economy.

2. Money Supply Measures

 Monetary Aggregates: The money supply is divided into several levels (M0, M1, M2,
etc.) that encompass different types of money, from the basic physical cash to deposits and
savings.
 Base Money (M0): The sum total of currency in circulation and reserves in the form of
coins and notes with the banks at the central bank.
 M1 and M2: Loosely defined as cash, demand deposits, and other highly liquid and easily
tradable near-monies.

Quantitative Tools for Controlling Money Supply:

1. Open Market Operations (OMO)
OMO is a monetary policy tool in which central bank buy and sell bonds to regulate the money
supply in the economy.
 Open market purchase: If central bank want to increase the money supply it purchase
government securities due to this amount of cash with commercial bank and people
increase. It’s done to control recession (expansionary policy)
 Open market selling: If central bank wants to reduce money supply it sells government
securities to commercial bank and people which will reduce the cash with commercial
bank. This will decrease the number of loans whereas people’s demand for goods and
services shrinks. It’s done to control inflation (contractionary policy)

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2. Reserve Requirements
This regulates the quantity of cash or liquid assets that the commercial banks should have with
them to counter their deposit liabilities. This action of increasing the reserve ratio means that
there is less money that can be lent out to the public, which in turn means a decrease in the
money supply. On the other hand when a central bank decides to reduce the reserve
requirements, this means that the banks are able to issue a higher number of loans leading to
expansion of the money supply.

3. Discount Rate
This is the rate of interest at which the central bank provides funds to the commercial banks.
Higher discount rate will mean that banks will not be interested in borrowing, hence a decrease
in the amount of money in circulation. On the other hand, Reduction of discount rate reduces
the cost of borrowing for the banks and in turn provokes the banks to borrow more and,
therefore, supply more money in the economy. The discount rate is a tool that can help in
managing expectations and shaping behavior of the financial markets as the central bank can
use it to signal its position on the course of monetary policy.

4. Payments on Excess Reserves:

Interest can be paid on the reserves which the member banks have in excess of the minimum
amount that is required to be held with the central bank. Thus, by raising the reserve
requirement ratio, the central bank is able to force commercial banks to hold more reserves
and curb lending activities and thus, decrease the money supply in the economy. This relatively
recent tool provides central banks with an additional instrument to influence the liquidity in
the banking sector.

5. Quantitative Easing (QE)

In order to put money directly into circulation, central banks purchase financial assets, such as
government and corporate bonds. It is applied when conventional measures are ineffective,
especially in conditions of low interest rates, to stimulate lending and investment.

Qualitative Tools:

1. Moral Suasion:
The central bank can work on the banks to encourage or discourage them to give out loans,
thus affecting the money supply without having to change the quantity tools directly.

2. Margin Requirements:
This is the minimum amount of capital that investors have to hold when purchasing
specific assets such as stocks. Higher margin requirements limit the funds that can be used
for speculation and thereby affect the money supply in an indirect manner.

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Implications of Controlling the Money Supply:
1. Inflation and Deflation:
 Inflation Control: Central banks can combat inflation by reducing the amount of money
in circulation; thus maintaining the value of money and preventing inflation from spiralling
out of control.
 Avoiding Deflation: On the other hand, to stimulate the economy and prevent deflation –
a detrimental decrease in prices and economic activity – the money supply needs to be
increased.

2. Economic Growth:
 Stimulating Growth: When the money supply is expanded, the interest rates go down,
and this makes it cheaper for people and companies to borrow money, and they are able to
invest and consume more.
 Cooling an Overheated Economy: Contracting the money supply can aid in controlling
inflationary pressures often associated with high levels of spending in the economy.

3. Interest Rates:
 Influencing Borrowing Costs: This is because by controlling the money supply in an
economy the central banks are able to manipulate the short term interest rates which has an
impact on the borrowing costs throughout the economy.
 Yield Curve Impact: Another channel through which the policy stance can influence
economic outcomes is through its effect on long-term interest rates and investment plans.

4. Exchange Rates:
 Currency Value: Variations in the money supply can also have an impact on the exchange
rate of the country’s currency in relation to others and this could affect trade and
investments.
 Competitiveness: Currency depreciation leads to increased exports as products become
less expensive for the international market while currency appreciation reduces the import
costs.

5. Financial Market Stability:

 Liquidity Management: Among its benefits, maintaining sufficient liquidity in the
financial system can reduce risks of financial crises, including bank runs or credit crunches.
 Investor Confidence: A well communicated and reliable monetary policy enhances
investor confidence and thus, stability of financial markets.

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