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A monetary system is a system where a
government A government is the system or group of people governing an organized community, generally a State (polity), state. In the case of its broad associative definition, government normally consists of legislature, executive (government), execu ...
manages
money Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context. The primary functions which distinguish money are: m ...
in a country's economy. Modern monetary systems usually consist of the national
treasury A treasury is either *A government department related to finance and taxation, a finance ministry; in a business context, corporate treasury. *A place or location where treasure, such as currency or precious items are kept. These can be ...
, the mint, the central banks and
commercial bank A commercial bank is a financial institution that accepts deposits from the public and gives loans for the purposes of consumption and investment to make a profit. It can also refer to a bank or a division of a larger bank that deals with whol ...
s.


Commodity money system

A commodity money system is a type of monetary system in which a
commodity In economics, a commodity is an economic goods, good, usually a resource, that specifically has full or substantial fungibility: that is, the Market (economics), market treats instances of the good as equivalent or nearly so with no regard to w ...
such as
gold Gold is a chemical element; it has chemical symbol Au (from Latin ) and atomic number 79. In its pure form, it is a brightness, bright, slightly orange-yellow, dense, soft, malleable, and ductile metal. Chemically, gold is a transition metal ...
or seashells is made the unit of value and physically used as money. The money retains its value because of its physical properties. In some cases, a government may stamp a metal coin with a face, value or mark that indicates its weight or asserts its purity, but the value remains the same even if the coin is melted down.


Commodity-backed money

One step away from commodity money is "commodity-backed money", also known as "representative money". Many currencies have consisted of bank-issued notes which have no inherent physical value, but which may be exchanged for a
precious metal Precious metals are rare, naturally occurring metallic chemical elements of high Value (economics), economic value. Precious metals, particularly the noble metals, are more corrosion resistant and less reactivity (chemistry), chemically reac ...
, such as gold. This is known as the
gold standard A gold standard is a backed currency, monetary system in which the standard economics, economic unit of account is based on a fixed quantity of gold. The gold standard was the basis for the international monetary system from the 1870s to the ...
. A silver standard was widespread after the fall of the
Byzantine Empire The Byzantine Empire, also known as the Eastern Roman Empire, was the continuation of the Roman Empire centred on Constantinople during late antiquity and the Middle Ages. Having survived History of the Roman Empire, the events that caused the ...
, and lasted until 1935, when it was abandoned by China and Hong Kong. A 20th-century variation was
bimetallism Bimetallism, also known as the bimetallic standard, is a monetary standard in which the value of the monetary unit is defined as equivalent to certain quantities of two metals, typically gold and silver, creating a fixed Exchange rate, rate of ...
, also called the "double standard", under which both gold and
silver Silver is a chemical element; it has Symbol (chemistry), symbol Ag () and atomic number 47. A soft, whitish-gray, lustrous transition metal, it exhibits the highest electrical conductivity, thermal conductivity, and reflectivity of any metal. ...
were
legal tender Legal tender is a form of money that Standard of deferred payment, courts of law are required to recognize as satisfactory payment in court for any monetary debt. Each jurisdiction determines what is legal tender, but essentially it is anything ...
.


Fiat money

The alternative to a commodity money system is
fiat money Fiat money is a type of government-issued currency that is not backed by a precious metal, such as gold or silver, nor by any other tangible asset or commodity. Fiat currency is typically designated by the issuing government to be legal tende ...
which is defined by a
central bank A central bank, reserve bank, national bank, or monetary authority is an institution that manages the monetary policy of a country or monetary union. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the mo ...
and government law as
legal tender Legal tender is a form of money that Standard of deferred payment, courts of law are required to recognize as satisfactory payment in court for any monetary debt. Each jurisdiction determines what is legal tender, but essentially it is anything ...
even if it has no intrinsic value. Originally fiat money was paper currency or base metal coinage, but in modern economies it mainly exists as data such as bank balances and records of credit or debit card purchases, and the fraction that exists as notes and coins is relatively small. Money is mostly created by banks when they loan to customers. Put simply, banks lending currency to customers, subject to each bank's regulatory limit, is the principal mode of new deposit creation. The central bank does not directly fix the amount of currency in circulation. Money creation is primarily accomplished via lending by
commercial bank A commercial bank is a financial institution that accepts deposits from the public and gives loans for the purposes of consumption and investment to make a profit. It can also refer to a bank or a division of a larger bank that deals with whol ...
s. Borrowers who receive the money created by new lending in turn affect the stock of money, as paying off debts removes money circulating. Although commercial banks create circulating money via lending, they cannot do so freely without limit. Commercial banks are required to maintain an on-hand reserve of funds equaling a portion of their total deposits banks (Large banks in the United States, for example, have a 10% reserve requirement.) Central banks set interest rates on funds available for commercial banks to borrow short-term from the central bank to meet their reserve requirement. This limits the amount of money the commercial banks are willing to lend, and thus create, as it affects the profitability of lending in a competitive market. In times of economic distress, central banks can act as a borrower to prompt the creation of new money as well; during quantitative easing they will buy
government bond A government bond or sovereign bond is a form of Bond (finance), bond issued by a government to support government spending, public spending. It generally includes a commitment to pay periodic interest, called Coupon (finance), coupon payments' ...
s and
mortgage-backed securities A mortgage-backed security (MBS) is a type of asset-backed security (an "Financial instrument, instrument") which is secured by a mortgage loan, mortgage or collection of mortgages. The mortgages are aggregated and sold to a group of individuals ( ...
.


Demurrage money

Demurrage currency is a type of money that is designed to gradually depreciate in value at a flat constant rate. A demurrage monetary system works similarly to a fiat monetary system, but there are major differences in how money is borrowed, lent, and created. Under the stamp scrip system proposed by Silvio Gesell, every bill of paper money had a set of 52 printed boxes (4 x 13), and a stamp worth 0.1% of the bill's face value would have to be purchased and stamped onto the bill's boxes each week in order to keep the money valid as legal tender. A central bank would issue the demurrage currency. Since the supply of money would gradually deplete due to demurrage, the central bank would be responsible for monitoring the money supply and printing to replace all the money that disappears due to demurrage. The money printing could create just enough inflation to cancel out the natural deflation of demurrage, thus achieving an inflation target of 0%. Under a fiat monetary system, inflation effectively works as a hidden tax. Under a demurrage monetary system, currency would have demurrage fees instead of inflation, which would be a more explicit and easier to measure tax on money. In Gesell's proposed system, the individual owners of Freigeld would pay the demurrage fee for the stamps to the government, thus reducing the amount of other taxes that a government would have to collect. If individuals do not want to pay the demurrage fees, they could deposit their money into a bank. The bank would become responsible for paying for the stamp fees, and the money would retain its full value from the depositor's perspective. Bank would thus be incentivized to
loan In finance, a loan is the tender of money by one party to another with an agreement to pay it back. The recipient, or borrower, incurs a debt and is usually required to pay interest for the use of the money. The document evidencing the deb ...
the money in order to pass the holding expense onto others and avoid paying for the stamps, which would guarantee that plenty of money would be available for lending in the economy. Gesell believed that banks would loan until their interest rates eventually fall to zero. Banks would collect only a small
risk premium A risk premium is a measure of excess return that is required by an individual to compensate being subjected to an increased level of risk. It is used widely in finance and economics, the general definition being the expected risky Rate of retur ...
and an administration fee, without any need to adjust for inflation or deflation. In some cases, demurrage currencies have been employed as emergency currencies, intended to keep the
circular flow of income The circular flow of income or circular flow is a economic model, model of the economy in which the major exchanges are represented as flows of money, Good (economics), goods and Service (economics), services, etc. between economic agents. The f ...
running throughout the economy during recessions and times of war, due to their faster circulation velocities.


See also

* Bretton Woods system * Causes of the Great Depression * Credit theory of money * Criticism of the Federal Reserve * Great Contraction * Imperial minting ordinance * Imperial minting standard * International monetary systems * Modern monetary theory * Monetarism *
Monetary economics Monetary economics is the branch of economics that studies the different theories of money: it provides a framework for analyzing money and considers its functions (as medium of exchange, store of value, and unit of account), and it considers how m ...
*
Monetary policy Monetary policy is the policy adopted by the monetary authority of a nation to affect monetary and other financial conditions to accomplish broader objectives like high employment and price stability (normally interpreted as a low and stable rat ...
* Money creation * Money supply * Price system * The Age of Debt Bubbles - book describing bubbles from banking debt money creation


References


External links


Historical documents, including discussions and debates regarding the use of various monetary standards
{{Central bank Banking Monetary economics Monetary reform Business terms