This article deals with ‘Money.’ This is part of our series on ‘Economics’ which is an important pillar of the GS-2 syllabus. For more articles, you can click here.
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 the barter system. Eg
- 1 kg rice for 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 the above problems, all persons will try to become Jack of all trades but master none.
- Don’t favour Industrialization: Industrialists will have to find a large supply line with every person having a double coincidence of demands.
- Don’t favour concentration of wealth: Since all the wealth is perishable. E.g., one can’t store tomatoes for an extended period.
- The problem of Divisibility of Value: In Barter System, you cannot always divide the value to buy whatever you want.
- Not always Fungible (Fungible items = Division & Mutual substitution is possible, e.g. Gold bars, Currency Notes & Coins. E.g., if a diamond is cut into smaller pieces, the summation of all the smaller parts will not be equal to one bigger diamond. Hence, diamond isn’t fungible).
Benefits of Barter System
- Promotes Joint Family
- Food Inflation will be lower in Barter Economy compared to Money Economy.
- Money is anything that is generally accepted as a means of payment.
- To answer the above limitations of the Barter System, Money System was invented.
- Money serves the following functions
a. Primary Functions
|Measure of Value|| |
Money serves as a measure of value. Eg
– Labour’s value in Money System is Wage
– Land’s value in Money System is Rent etc.
|Medium of Exchange|| |
– It is the medium of exchange because it has generalized purchasing power.
– E.g., Person earns money from his labour, and that money is used to buy food.
b. Secondary Functions
Due to the above Primary Functions, it can be used for various Secondary Functions as well
|Store of Value||– Value of labour paid in form of money can be stored in the form of money for later use |
– Eg: A person can store the value of his labour ie wage for later use.
|Transfer of Value||– Value paid in form of money can be transferred to another place as well.|
– Eg : A person earning in Bangalore can transfer it to his Parents in Punjab.
|Deferred Payment||– It serves as a standard for the settlement of future monetary obligations. We can make deferred payments like paying in advance (like Paying Rent of Dish TV at once) or Paying later (e.g. taking the 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 the Redistribution of National Income (via a system of taxation).
Evolution of Money
1 . Commodity Money
- It is the first stage in the Evolution of Money
- In this, a particular commodity is used to measure the value.
- E.g., 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
2. Metallic Money
Traders and Kings used to stamp their marks on Coins to ensure that metal was of uniform quantity and quality.
- It has intrinsic value.
- It is non-perishable
- It is divisible & fungible.
- Even foreign trade is possible
Full-Bodied Coin vs Token Coin
1. Full-Bodied Coin
- It is the money whose intrinsic value is equal to or greater than face value.
- It is also known as good money.
- E.g., One Rupee Coin of British India (shown below) had a face value of 1 ₹, but if somebody melted the silver and sold that in the market, it was greater than 1 ₹.
2. Token Coin
- It is the money whose intrinsic value is lower than its face value.
- It is also known as Bad Money.
- E.g., Present 1 ₹ Coin.
Issues with Full Bodied coin
- Full-Bodied coins result in various problems. People start to melt metal from the coin and use it for other things.
- The same thing was seen in the recent past in Indian Coinage too. Indian ₹5 Coins were sent to Bangladesh, where the cost of metal was more. They used to melt the coin and make blades out of that. Cupro-Nickel coins were introduced to tackle such activities.
- Apart from that, to adjust to inflation, the government keeps on reducing the metal content in the coins to keep the intrinsic value of the coin lesser than its face value. Melting Coins to use for other purposes is a punishable offence.
Issue of Debasement in Coins
- In historical studies of the coinage system, the issue of Debasement was important. E.g., during the Akbar regime, 1 Dam (copper coin) had 20 grams of metallic copper. But due to economic problems of the empire during the times of Aurangzeb, the Dam consisted of just 13 grams of metallic copper.
- But Debasement leads to other problems. Since in those times, people had confidence in the Coinage System because of the coin’s intrinsic value, reduction in Metallic content reduced the confidence of people in the coinage system, and they started to move towards the Barter System of payment, reducing the state’s tax income. Furthermore, the state used to take a commission for minting the coin, and the reduction in the use of coins further weakened the economy.
3. Paper Currency
- The genesis of paper currency can be traced back to Hundis, in which traders used to pay metal at one place and take Hundi to avoid any theft while carrying metal during a large voyage. Later, State started to do the same work and introduced Paper Currency.
- Hence, it is called Fiduciary Money, i.e. although the paper has no intrinsic value of its own, it is circulated because of trust in issuing authority.
Types of Fiduciary Money
1. Non-Legal Tender
- It is not issued by the government
- E.g., Bill of Exchange, Cheque, Bank Draft, Postal Orders etc.
- It is also called Optional Money because its acceptance is optional.
2. Legal Tender/Fiat Money
- It is issued by the government and act as money on the fiat or order of the national government.
- It can be classified as Coin and Currency
- Its acceptance is not optional within the boundary of the country. It can’t be denied for settlement of any monetary obligation.
Types of Legal Tender
1. Limited Legal Tender (Coin)
- It can be used to settle a limited amount of debt.
- According to Coinage Act, 2011
- Using 50 paisa Coins, a maximum debt of ₹10 can be settled.
- Using ₹1 coin or above, a maximum debt of ₹1,000 can be settled.
- All coins below 50 paise are not legal tenders now (since 2011).
2. Unlimited Legal Tender (Currency)
- It can be used to settle the unlimited amount of debt binding by the government’s command.
- Every banknote is legal tender in India.
Who Issues what?
- The government issues all coins. Government can issue any amount of coin (even 1,000 ₹ coins).
- The government issues ₹ 1 Note with the sign of the Finance Secretary on it.
- ‘Anna system’ was changed to ‘Decimal system’ by amending Coinage Act in 1955.
- Under RBI Act, all Notes except ₹1 can be issued by RBI with the sign of the RBI Governor.
How Fiat Money is issued?
a . Earlier Times
- Gold Standard System: Earlier, Bank Notes were backed by an equivalent amount of gold. Notes amounting to the 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
- If this note was taken to Central Bank, it paid an equivalent amount of gold in return.
- But later, due to various problems like printing more cash during wars, the cold war and depressions, this system was discarded.
b. Indian System
Earlier, the following system was used
1935 to 56
- RBI used to maintain 40% gold to the value of currency issued.
1956 to 95
- India abandoned the old system and moved to the ‘Minimum Foreign Reserve System.’
- Under this, RBI was required to maintain a total reserve of at least Rs. 200 crore with at least Rs.115 crore in form of gold and the rest in form of Foreign Securities.
1995 to Present
- India is following the ‘ Managed Paper Currency Standard‘.
- Under this system, the Government of India can print any amount of money under the backing of gold, foreign securities and Government of India backed Securities.
- Hence, if the government wants to print more money (than gold and foreign currency), the government will issue securities (G-Secs) to RBI and RBI in return, will print equivalent money with the backing of those securities.
What does it mean?
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.
Examples: Fiat Money & Legal Tender
E.g. US Dollars
- It is fiat money as it is issued by some government.
- It is legal tender in the USA but not in India.
Side Note: Mahatma Gandhi New Series Notes and portraits on them
|₹ 10||Sun Temple, Konark, Odisha.|
|₹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|
Other Information about Indian Currency
- ₹ sign designed by D.Udaya Kumar (Associate Professor @IIT Guwahati).
- While the 8th Schedule has 22 languages, but currency note has only 17.
- Visually impaired old series notes have square (50), triangle (100), circle (500), diamond (1000), new series notes have bleed lines, raised printing of Gandhi etc.
- Demonetisation is the wholesale withdrawal of currency from circulation.
- Every banknote is a “legal tender”. But on RBI Board’s recommendation, the Government of India notifies that Specific Bank Notes (SBN) are no longer legal tender (i.e. Demonetized).
- 8/Nov / 2016 : ₹500 & ₹1000 notes were demonetised.
- Specified Bank Notes (Cessation of Liabilities) Act 2017: The government passed this Act to give legislative backing to Demonetisation. RBI was not required to honour the promise written on old banknotes. A limited number of Old notes can’t be kept except for research, or numismatics, or museum.
4. Bank Money
- The backend of Bank Money is Fiat Money as well.
Examples of Bank Money
- Demand Draft: can’t be dishonoured because the amount is prepaid.
- Overdraft: When a person’s bank account has an 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 a long distance.
- The exact amount can be transferred.
- Hard to counterfeit.
- Can freeze if stolen.
- Leave behind a digital trail.
- Legally recognised for high-value payment.
Types of Accounts
1. Saving Account
- These are opened by households.
- There are some restrictions on transactions.
- Banks offer low interest on these accounts.
- It has demand and time liability.
2. Current Account
- These are opened by business entities (firms or businessmen).
- There are no restrictions on transactions.
- Banks offer no interest on these accounts.
- It has demand liability.
3. Fixed Deposit Account and Recurring Deposit Account
- Anyone can open this account (but generally, these are opened by the households because they are the savers in the economy).
- There are some restrictions as banks are not liable to pay back until the end of the period for which money was deposited in the bank.
- Banks offer a relatively high-interest rate on these deposits (6 to 10%).
- It has time liability.