State's Role in Money: Origins & Evolution - Essay Sample

Introduction

The classical view is that money is a medium of exchange and that the government can exert control over it through taxes and loans to balance its supply and demand (Von, 2012). Many theories also assert that the value of money is a factor of its scarcity (Bell, 2001). The state puts money in place as a general legal unit of payment for settling obligations and then pricing every commitment. The state has indeed played a significant role in the origins and evolution of money. Money has been the principal mode of contract commitment and legal tender laws. This explanation is called the Chartalist approach, which postulates that the value of currency corresponds with the power of the government (Von, 2012). This paper explains that money is a creature of the state, but with the powerful influence of the market and societal conventions.

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Barter Trade

Early civilizations traded goods and services for other products and services without using money or any form of currency (Keen, 2015). This exchange is caller barter trade. For example, a yam farmer can give their yams to a chicken farmer to get some chicken, and they both accept the deal as final. Barter still happens in modern society in the form of swap markets and online auctions (Bell, 2001), though it is not a way of business that can be solely depended on. The advantage of barter trading is that it does not require such a scarce payment method as money or gold to complete. A person uses what they have to get what they need.

People can exchange related items like houses when vacating or unrelated items like service for a good. But barter as a trading method had limitations. Firstly, it could be hard to get someone with matching needs to exchange goods with. Secondly, there is no consumer protection, and someone may get duped or receive fake or defective products. The process is also time-consuming as some unrelated goods may be hard to value. These challenges are what created the need for currency in society, which now is money.

The Value of Money

Money, in itself, has no significant value, but the form of it is attached to a historically accepted value to drive trade and exchange of goods and services. Money is the ultimate convention that recognizes the value of wealth and the order of the state (BBC, 2015). It is essential to indicate that the state indeed has power in the process of money creation and recognition. Money creation can be defined as the process through which the supply of money in a country is enriched (Pettifor, 2018). In most modern states, the process happens in commercial banks under the watch of the state's central bank.

Today, money exists in two forms, currency and book money. Currency includes the notes and coins in circulation and makes up to five percent of the country's money while book money is money held in accounts of bank customers and accounts for 95 percent of a country's money (Coppola, 2019). Most of the time, the bank loans out the book money for interest and profit, thus increasing the cash flow in the economy but reducing the individual bank's liquidity. This is why banks' greatest fear is panic withdrawals among customers in the face of a crisis because they will not afford to issue banknotes for every money in their accounts.

In the modern world, money is universally accepted as the primary medium of exchange, a store of wealth, and a unit of measurement (McLeay, Radia, & Thomas, 2014). During the metalist period, the amount of money supply in a country corresponded to an amount of gold and silver physically held in banks (Pistor, 2013). Banks would have to exchange physical gold whenever check transfers were done. This process was cumbersome and time-consuming, and, today, money revolves in the form of loans. Banks hold money in reserves for account holders and loanees to be able to re-loan the saved money. The government plays its part by buying securities using newly printed money and by maintaining reverses for local banks (Sgambati, 2015).

Many economists faulted the metalistic or golden era was for being impractical (Faure, 2012). With rapidly growing populations and dramatically expanding trade, the demand would soon exceed the supply of gold. The era meant that the only way to solve a shortage of money supply would be to mine more gold, which was not realistically feasible (Sgambati, 2015). Nonetheless, because of its natural scarceness, the use of gold entirely controlled oversupply of money and kept inflation at bay.

Money Creation by Commercial Banks (Credit Multiplier)

By issuance of loans, banks help in the creation of money (Faure, 2012). The money so lent gets invested in the economy and ends up in citizen's pockets in the form of wages. It may be used to pay school fees, build apartments, buy houses, build hospitals, or to expand farms, which all lead to development in the country and wage payment to the involved citizens. In some way, the money ends up getting deposited back to the bank, who can loan it out again, leading to credit multiplication.

Simply put, the issuance of loans results in the creation of money, while the repayment of loans leads to money destruction (Pistor, 2013). The stock of money is controlled majorly by its demand, government regulation, and the financial conditions of banks. According to Faure (2012), the central bank's ability to create money is dependent on the government's spending and taxation efficiencies.

The Role of The State

Money exists in many forms today, including physical bills, bank balances, checks, short-term notes, money markets, etc. From the parameters above, it is evident that the government can have an estimate of how much money is in circulation in the economy. If the state wants to add more money into circulation, for instance, one billion Dollars, they will buy Treasury bonds worth the same value in the market. Before making investment decisions, investors review government financial patterns closely to be able to give a reasonable estimate of the country's working money supply. The government can also act to recall currency from circulation and destroy it if there is an oversupply of the same (Coppola, 2019). They will sell the treasury bonds and destroy the currency.

All these measures show just how important the government is in the creation and acceptance of money. Society understands the government's role in it, and money gets value from its functions (money is what money does) (McLeay, Radia, and Thomas, 2014). As a medium of exchange, money serves as a mode of payment. This valuable role of money is why some scholars see it as a conventional making of the market rather than a government's creation. Money is the ultimate solution for the double coincidence of wants because it settles debts and payments rather than just promoting the exchange of goods and services. Money also serves as a store of wealth and is expected to retain its value for the period that someone holds it (Pettifor, 2018).

The Fiat System

The actual role of money plays out after it joins the market, which is its "home." As a circulating means of payment, money is ubiquitous but still scarce. In the modern times of the state and money, there is the fiat monetary system. This structure stands that what the government prints as money will serve as legal tender for payments and contracts (Keen, 2015). The government-printed money gives a person purchasing power and a storage medium for wealth. The money also empowers communities and societies to grow while sharing and trading their resources and forging towards the future. It promotes development, industrialization, politics, and education.

Since money has enabled people to specialize in their fields of expertise, it has served as a reliable store of purchasing power. Before money, people mostly had to rely on their own resources, or find someone who needed exactly what they produced and was offering what they needed. That barter process was cumbersome, inconvenient, and time-consuming. Thus, a person can sell their produce for money and then use the money to buy what they need. Based on a country's political stability, resources, and economic strength, the central bank determines the value of the currency (Bell, 2001). All the money in the world today is fiat money because people have entrusted faith and confidence in its ability to preserve purchasing since the government named it the legal tender.

Monetarism

The central bank may also decide to inject money into the economy without buying any assets or without loaning it to banks. This kind of response is called a "helicopter drop" according to Milton Friedman (a Nobel Price-winning American economist), and may make the central bank technically insolvent (Keen, 2015). The bank can recover from this if the government efficiently and fairly taxes the population. The government's efficiency at taxing the population depends on its legitimacy according to the community and the productive power of the country. In a county like Zimbabwe, the government was less credible, and people mistrusted the power of the currency that is created, leading to hyperinflation (Pettifor, 2018).

Milton Friedman proposed the monetarism theory, which postulates that shifts in a country's money supply significantly affect national output and price levels in the short and long terms, respectively (In Von, 2012). The proponents of this theory argue that the purpose of monetary policy can be met best by controlling the supply of money and not by discretionary fiscal policy. They also emphasize that the central bank's role is to maintain the growth of money availability and keep it balanced with increase in demands for goods and the nation's productivity (Keen, 2015). An oversupply of money leads to inflation, and central banks must always strive to balance it to keep the currency stable.

Friedman proposed Friedman's k-percent rule, which suggests an automatic fixed percentage yearly increases in the money supply from the central bank (Coppola, 2019). The national reserve bank would have no role since computer systems would generate the percentage increases. He thus thought that when the central bank keeps actively manipulating the supply of money in the country, the currency gets weakened rather than strengthened (Coppola).

The Market in Money Creation

To properly outline the dynamics that play in the market that lead to money creation, it is essential to explain how banks connect to the market and vice versa. Money has become a multi-faceted and penetrative part of society, and that is why people have very varied opinions of what it is and its creation process. Many people grow an increasing desire for money because other people also desire it. Scholars have drawn comparisons between monetary trading versus barter trading environments. Augusto Graziani, an Italian Economics professor, was among the first to review the differences and similarities. Augusto poked holes on the metalistic era, positing that gold, like any other metal, can be acquired by any hardworking person by mining, and this is a commodity and not money (In Sgambati, 2015). Therefore, trading with gold still classifies as barter trade, according to Graziani.

Augusto explained that gold gets obtained through a method of production, and thus any producer can make it for themselves. He, therefore, suggested that the acceptable form of money is token money, as the paper currencies in use today (In Sgambati, 2015). But the token definition of money was not satisfactorily conclusive because other forms of tokens like bills of exchange, which facilitate transactions in...