To explain the money system, we should look at how money is born. In pretty much every country on Earth, one of the ways new money can be born involves a central bank. If the bank feels that an increase of the money supply would help us, it can just make more money. It’s that easy. It doesn’t even need to be printed as currency to be born. The next step involves the commercial banks. These are the banks that you and I use to cash checks and deposit money. All the central bank needs to do is buy some things from these banks using the money it just made and now the commercial banks have more money.
There’s another way money can be born. It involves commercial banks. If I go to the bank and deposit $500, the bank says, “fantastic,” we will hold on to this money for you and at any time you want, you can withdraw or spend these $500. The thing is, legally, banks only need to reserve a fraction of the money that they are given. This is known as fractional reserve banking. It means that if someone else comes along, say, Bob and he wants to borrow some money, say, 300 dollars, the bank can lend him $300. And now, whenever he wants he can spend these 300 dollars. But here’s the thing: Bob can spend $300 and I can spend $500 for a total of $800, despite the fact that there are only 500 dollars in the bank. By the way, you can act just like a central bank and control the money supply yourself. It is illegal, but you can technically increase the money supply by counterfeiting and you can decrease the money supply by subtracting money. For instance, burning it.
If you burn your own money, you become poorer, but because you’ve decreased the money supply, the power of everyone else’s money goes up and they become a tiny bit richer. Of course, given the amount of money you could probably get your hands on and burn, your effect will be quite imperceptible. In a world, where nothing was stable and survival was a challenge, food, clean water, antibiotics, and machines of those types of things would be our economy. When what you use as money has an intrinsic value, it’s useful in and of itself, it is known as commodity money. It can also include precious metals, like gold, and silver whose rarity makes it likely to be accepted by other people for goods and services. Now, when you can safely store all of your commodities in one place and you don’t need a defend them or lug them around everywhere, representative money often makes more sense. Store your valuables in a trusted place like a bank and get some slips of paper from them, saying “yeah, I own that stuff.” Now you can walk around with some easy to carry slips of paper and use those to buy the things that you want. We are now closer to what we call money today. I say closer, because almost all money that we know of today doesn’t represent any actual useful commodity anywhere on Earth. This note doesn’t represent how much food or water or gold or spices or video games I have stocked up in a bank, it just is money. It’s called fiat money
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