Money

Money

This article deals with ‘Money.’ This is part of our series on ‘Economics’ which is important pillar of GS-2 syllabus . For more articles , you can click here

Barter System

  • People have been trading with each other even before the advent of money, coin, cash, currency, rupee, dollar, euro or Yuan. They simply exchanged goods and services with each other through barter system. Eg
    • 1 kg rice for a 200 grams tomatoes
    • 1 kg tomatoes for 50 gm almonds and so on

Problems with Barter System

  • It can happen  only with Double Coincidence of wants
  • Search Cost / Cost of Transaction is high.
  • Don’t favour Division of Labour / Specialization : Due to above problems, all persons  will try to become Jack of all trades but master of none.
  • Don’t favour Industrialisation : Industrialist will have to find large supply line with every person having double coincidence of demands 
  • Don’t favour Concentration of wealth : Since all the wealth is perishable. Cant store tomatoes  for long period of time
  • Problem of Divisibility of Value : In Barter System , you cannot always divide the value to buy whatever you want to.
  • Not always Fungible

(Fungible items = Division & Mutual substitution possible e.g. Gold bars, Currency Notes & Coins . Eg : if diamond is cut into smaller pieces , summation of all the smaller parts will not be equal to one bigger diamond . Hence, diamond isn’t fungible)

Fungibility

Benefits of Barter System

  • Promotes Joint Family
  • Food Inflation will be lower in Barter Economy compared to Money Economy.

Money

  • To answer above limitations of Barter System, Money System was invented
  • Money serves following functions
Functions of Money

a. Primary Functions

Measure of Value Money serves as measure of value.

Eg :
1. Labour’s value in Money System is Wage
2. Land’s value in Money System is Rent etc
Medium of Exchange It is the medium of exchange.
Eg : Person earns money from his labour and that money is used to buy food 

b. Secondary Functions

Due to above Primary Functions, it can be used for various Secondary Functions as well

Store of Value Value of labour paid in form of money => person can store the value for later use 
Eg : Person can store value of his labour ie wage for later use.
Transfer of Value Value paid in form of money   can be transferred to other place as well
Eg : Person earning in Bangalore can transfer it to his Parents in Punjab
Deferred Payment We can make deferred payments like paying in advance (like Paying Rent of Dish TV at once) or Paying later (eg taking car on loan)
This is possible because we can measure the time value of Money using Interest Rate

Benefits of Money Economy

  • Due to Money’s Primary and Derivative Functions, it can be used for Social Empowerment, Dalit Entrepreneurship etc. Labour and Service of each kind can be paid which wasn’t possible in Barter Economy.
  • It also helps in Redistribution of National Income (via System of Taxation)

Evolution of Money

Evolution of Money

1 . Commodity Money

  • This is the first stage in Evolution of Money
  • In this, a particular commodity is used to measure the value .
  • Eg : Cocoa Beans (used by Aztecs) . Cowry Shells (in India) , Cigarettes (in Jails) etc
  • Note – Commodity Money has Intrinsic Value too

Different Examples of Commodity Money 

Examples of Commodity Money

2. Metallic Money

  • In this, Traders and Kings used to stamp their marks on Coins to ensure that metal is of uniform quantity and quality.

Benefits

  • It has Intrinsic Value
  • It is Non Perishable
  • It is divisible & fungible
  • Even Foreign Trade possible

Full Bodied Coin vs Token Coin

Full Bodied Coin In this , Intrinsic Value of Coin is equal to or greater than face value
Eg : One Rupee Coin of British India (shown below) had face value of 1 ₹ but if somebody melted the Silver and sold that silver in the market, it was of greater than 1 ₹ .
Token Coin In this, Intrinsic Value of Coin is lower than its face value
Eg : Present 1 ₹ Coin
FUll Bodies Coin vs Token Coin

Issues with Full Bodied coin

  • Full Bodied coins result in various problems . People start to melt metal from Coin and use it for other things.
  • Same thing was seen in recent past in Indian Coinage too. Indian ₹5 Coins were send to Bangladesh where cost of  metal was more . They used to melt the coin and make blades out of that.  To tackle this, Cupro-Nickel coins were introduced so that such activities can be stopped .
  • Apart from that, in order to adjust to inflation, government keep on reducing the metal content in the coins to keep the intrinsic value of coin lesser than its face value. Along with that, Melting Coins to use it for other purpose is punishable offence .

Issue of Debasement in Coins

  • In historical studies of coinage system , issue of Debasement is important. 
  • Eg: During the regime  of Akbar , 1 Dam (copper coin) had 20 gram of metallic copper . But due to economic problems of empire during the times of Aurangzeb, Dam consisted of  just 13 grams of metallic copper.
Debasement of Coins
  • But debasement leads to other problems. Since in those times, people had confidence in the Coinage System because of the intrinsic value of the coin , reduction in Metallic content  reduces the confidence of people in the coinage system and they start to move towards Barter System of payment. As a result, state’s tax income decreases. Along with that, state used to take commission for minting coin. Reduction in use of coinage system further weakens the economy and vicious circle ultimately leads to collapse of whole economy 

3. Paper Currency

  • Genesis of paper currency can be found in Hundis in which traders used to pay metal at one place and take Hundi in order to avoid any theft while carrying metal during large voyage. Later , State started to do the same work and introduced Paper Currency.
  • Hence, it is called Fiduciary Money i.e. although paper has no intrinsic value of its own but it is circulated because of trust in issuing authority.

Types of Fiduciary Money

a. Non-Legal Tender

  • Not issued by the Government
  • Eg : Bill of Exchange , Cheque , Bank Draft, Postal Orders
  • Also called Optional Money because its acceptance is optional

b. Legal Tender / Fiat Money

  • It is issued by the Government
  • Can be classified as Coin and Currency
  • It’s acceptance is not optional (have to accept) within the boundary of nation

Types of Legal Tender

b.a Limited Legal Tender (coin)

  • It can be used to settle limited amount of Debt
  • According to Coinage Act , 2011
    • Using 50 paisa Coins , maximum debt of ₹10 ( can be settled)
    • Using ₹1 coin or above, maximum debt of ₹1,000 can be settled.
    • All coins below 50 paisa are not legal tenders now (since 2011) (asked in UPSC – CDS)

b.b Unlimited Legal Tender (Currency)

  • Can be used to settle unlimited amount of debt binding by the command of Government
  • Every Bank Note is legal tender in India.

Who Issues what ?

Government – All coins are issued by Government. Government can issue any amount of Coin (even 1,000 ₹ coin)
– ₹ 1 Note is issued by Government with sign of Finance Secretary on it
‘Anna system’ was changed to ‘Decimal system’ by amending Coinage Act in 1955 
RBI Under RBI Act , all Notes except ₹1 can be issued by RBI with sign of RBI Governor on it

How Fiat Money is issued ?

a . Earlier Times

  • Gold Standard System : Earlier , Bank Notes were  backed by equivalent amount of gold . Notes amounting to equivalent reserve of gold were issued. Eg
    • 1 US dollar was issued against 22 grain gold
    • 1 British Pound was issued against 113 grain gold
Gold Standard System
  • If this note was taken to Central Bank, it paid equivalent amount of Gold in return. 
  •  But later due to various problems like printing more cash during wars, cold war and depressions,  this system was discarded.

b . Indian System

1935 to 56 RBI used to maintain 40% gold to value of currency issued .  
1956 to 95 India abandoned old system and moved to ‘Minimum Foreign Reserve System
Under this, RBI was required to maintain 115 crore worth of gold and Rs. 400 Crore worth of Foreign Currency Security.  
1995 to Present India is following ‘ Managed Paper Currency Standard‘ .
It means that, if any person with any bank note issued by RBI goes to RBI to exchange that note, RBI is bound to give him other notes and Token coins of equal face value.  
Managed Paper Currency Standard

Side Note : Mahatma Gandhi New Series Notes and portraits on them

₹ 10 Sun Temple, Konark, Odisha.
₹20 Ellora Caves
₹50 Humpi Chariot of Vittala Temple 
₹100 Rani ki Vav on Saraswati river, Patan
₹200 Sanchi Stupa, Madhya Pradesh
₹500 Red Fort, Delhi
₹2000 Mangal Yaan / Mars Orbiter Mission

(In Arts and Culture, prepare about these sites with care)

Other Information about Indian Currency

  • ₹ sign designed by  D.Udaya Kumar (Associate Professor @IIT Guwahati)
  • While 8th Schedule has 22 languages, but currency note has only 17

Demonetisation

  • Wholesale withdrawal of currency from the circulation
  • Every bank note is a “legal tender” . But on RBI Board’s recommendation, Government of India notifies that Specific Bank Notes (SBN) are no longer legal tender (ie Demonetized)
  • 8/Nov / 2016 : ₹500 & ₹1000 notes were demonetised
  • Specified Bank Notes (Cessation of Liabilities) Act 2017: Government passed this Act to give legislative backing to Demonetisation .RBI was not required to honour the promise written on old bank notes. Limited number of Old notes can’t be kept except for research or numismatics or museum

4. Bank Money

  • Backend of Bank Money too has Fiat Money .
Bank Money

Examples of Bank Money

  • Cheques
  • Demand Draft : can’t be dishonoured because amount is prepaid.
  • Overdraft : When person’s bank account has  insufficient balance, still he is  allowed to draw more money than available in his bank (as a loan).
  • Debit and Credit Cards
  • Net Banking System
  • Unified Payment Interface (UPI) System

Advantages of Bank Money

  • Easy to transfer over long distance
  • Exact amount can be transferred
  • Hard to counterfeit
  • Can freeze if stolen
  • Leave behind digital trail
  • Legally recognised for high value payment

5. Crypto Currency

Genesis of Crypto Currency

  • During Sub-prime crisis, Central Bank of US & other developed countries adopted Easy Money Policy & as a result purchasing power of $ decreased. Main cause of Subprime Crisis was Banks who had given loans to Subprime Borrowers. Hence, anarchists argued that Banks who were earning by charging fees , after their failure made common people to suffer by reducing the purchasing power of their hard earned money.
  • Cyber Anarchists decided to withdraw from Banking System and start currency of their own which will not depend on Central Bank of any country .

Timeline

  • 2008 : Satoshi Nakamoto (name of online user but no body know who he is) issued Online Paper .
  • 2009 : Operation of Bitcoins started
  • 2016: Australian businessman Craig Wright claimed he is Satoshi Nakamoto (but majority don’t believe this)
  • 2020 : Price of Bitcoin started to rise amidst Corona crisis due to fear that governments will print money in excessive amounts to cover the fall in tax collections and to cover unemployment benefits.

What is Crypto-Currency

  • Cryptocurrency is a digital currency created, stored and transacted using blockchain technology.
  • Examples : Bitcoin, Digicoin, Litecoin, Etherium, Laxmicoin etc.
  • Bitcoin invented by  Satoshi Nakomoto (anonymous) is the most popular.
Crypto-Currencies

How Bitcoins work ?

a. Technically Incorrect Example

  • Suppose there is gold mine and person started to mine it with  tools. All the gold that is mined is converted to coin with serial number on it by person sitting at exit of mine and registered  in Ledger
  • The Coin that is produced can be broken into smaller coins in order to pay for smaller transactions. But each time bigger coin is broken to smaller coins, separate Registration number is given to it and it is registered in Ledger again.
working of bitcoin

b. Working of Bitcoin

  • Instead of Gold Mine , Satoshi Nakamoto has generated Cryptographic ‘Data Cube’  with algorithm . This Cube can be mined using computer . When whole of ‘Data Cube’ will be mined, total of 21 million bitcoins will be generated .
  • Basic condition is same here as well. Each and every coin that is generated has to be registered in Public Ledger.
  • Bitcoin is divisible upto 10^8 Satoshi. But each time Bitcoin is divided, it has to be registered in Public Ledger. Hence. every transaction is registered in Public Ledger. For updating Ledger, Blockchain Technology is used (more on this later)
Working of Bitcoins

Bitcoin Wallet

  • Bitcoin Wallet looks like other Wallets (like PayTM Wallet)
  • One can send money to any person using his Bitcoin-wallet’s Address and Password (Wallet address is random alpha-numeric)
  • But there is no requirement of Name, Mobile Number and KYC Norms. One can send Bitcoins to other person without knowing identity of other. Hence , it is very anonymous .
Bitcoin Wallet

Benefits of Cryptocurrency

  • Cost-effectiveness in International Use : Electronic transactions to other countries are expensive due to currency conversion & processing fee levied by banks. Cryptocurrencies solve this problem, as they have single valuation globally
  • Privacy Protection: The use of pseudonyms conceals the identities, information and details of the parties to the transaction
  • They are difficult to counterfeit compared to physical currency because they use Blockchain Technology
  • Immunity from Government’s Financial Retribution:  For citizens in repressive countries, where governments can easily freeze or seize the bank accounts, cryptocurrencies are immune to any such seizure by the state.

Problem with Bitcoins

  • Used in carrying Illegal Activities because of Anonymity it offers
    • Various sites selling Drugs and other banned substances through Bitcoins like Silk Road came up 
  • Bitcoins are used by criminals in case of cyber attacks . Eg Wannacry episode
  • Bitcoins also started to be used for Tax Evasion and Terror Finance etc
  • Government is deprived of it’s taxes. Eg :On selling gold , government charges Capital Gains Tax  but Bitcoin transactions are difficult to trace
  • Climate Change  : Experts estimate that cryptocurrency mining related electricity consumption generates 20 megatonne CO2 annually
  • Due to Bitcoin mining, demand of  Graphic cards has increased and consequently price of graphic card has been doubled . Along with that, this is resulting of generation of tons of e-waste bad for ecology.
  • Uncertain Regulatory Environment
  • Uncertainty over Consumer Protection and Dispute Settlement Mechanisms: as Cryptocurrencies are decentralised
  • Highly Volatile : Explained Below
  • No intrinsic value : Explained below

Bitcoin Bubble / High Volatility ?

Bitcoin Bubble

Whether this is Bubble or not ?

  • Enthusiasts argue that cryptocurrencies like bitcoin are rapidly transforming into mainstream money that will offer serious competition to national currencies issued by central banks. Therefore they see bitcoin’s current price rise as merely a reflection of its bright future as a stateless currency. 
  • Skeptics have pointed to the Tulip Bubble of the 17th century and Internet stocks of the late 1990s as cautionary examples.  Bitcoins have no intrinsic value and their exponential rise is driven by emotion rather than value .

India and Bitcoin

  • Budget 2018 on Cryptocurrencies
    • Finance Minister clarified  that Crypto-currencies are not legal tenders in India. 
    • Government will eliminate the use of cryptocurrencies as part of the payment systems. 
    • BUT, India will use block-chain technology on which cryptocurrencies are based for encouraging the digital economy.
  • 2019 : Draft bill made by Finance Ministry wrt Cryptocurrencies
    •  Finance Ministry has made Draft bill called ‘Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019’ which bans the use of all types of cryptocurrencies issued by private operators and has provision of jail upto 10 years.
    • However, it permits RBI to launch Blockchain based digital currency
  • RBI on Cryptocurrencies
    • RBI has notified all the regulated entities (like Banks, Card Companies etc) that they can’t help anyone to buy/sell bitcoins or any other Virtual Currency
    • April 2018 Monetary Policy update : Cryptocurrencies  are dangerous wrt consumer protection and can be used for money laundering.

Virtual Currencies  & World

Different countries have different stance

Some countries have restricted and prohibited the use of Virtual Currencies (India, China, Bolivia etc)  while others allow it’s use in regulated form (Japan, US, Australia, South Africa etc)

Virtual Currencies and Blockchain Based things started by various countries

Bond-i Bond issued by the World Bank in Australia which is based on Blockchain technology .  
UNICEF and Bitcoins In October of 2019 , UNICEF announced that they will accept donations through Bitcoins along will all the other sovereign currencies of the world .  
China October 2019 : People’s Bank of China announced that they will launch their own Crypto-currency  
Petro In 2018 – January, President Nicolas Maduro announced the following: 1. Government of Venezuela decided to issue 100 million Petro coins – a type of cryptocurrency.
2. Price of 1 Petro coin = market price of one oil barrel from Venezuela.
 
SOV  – Marshall Island’s legal tender is US Dollar.
In 2018-February, they launched a sovereign cryptocurrency, called “Digital Sovereign” or SOV. However, unlike BITCOINS, this SOV will not have any anonymity.
 
Libra Cryptocurrency announced by Facebook .
Unlike other Cryptocurrencies, Mark Zuckerberg has announced that it will be backed by assets in reserve. But countries like France have openly rejected Libra as it will set precedent of currencies of MNCs and challenge the sovereignty of nation states .  


Side Topic : Stable Coins
Cryptocurrencies backed by assets like Libra

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