What Is Money?
Who Creates Money and The true Value of Money
Impressions Create Everything
The lack of transferability of bartering for goods is tiring, confusing, and inefficient. But that is not where the problems end; even if the person finds someone with whom to trade meat for bananas, they may not consider a bunch of bananas to be worth a whole cow. Such a trade requires coming to an agreement and devising a way to determine how many bananas are worth certain parts of the cow.
Money is a medium of exchange; it allows people to obtain what they need to live. Bartering was one way that people exchanged goods for other goods before money was created. Like gold and other precious metals, money has worth because for most people it represents something valuable. Fiat money is government-issued currency that is not backed by a physical commodity but by the stability of the issuing,
Commodity money solved these problems. Commodity money is a type of good that functions as currency. In the 17th and early 18th centuries, for example, American colonists used beaver pelts and dried corn in transactions.
Possessing generally accepted values, these commodities were used to buy and sell other things. The commodities used for trade had certain characteristics: they were widely desired and, therefore, valuable, but they were also durable, portable, and easily stored.
Another, more advanced example of commodity money is a precious metal such as gold. For centuries, gold was used to back paper currency—up until the 1970s. In the case of the U.S. dollar, for example, this meant that foreign governments were able to take their dollars and exchange them at a specified rate for gold with the U.S. Federal Reserve.
What's interesting is that, unlike the beaver pelts and dried corn (which can be used for clothing and food, respectively), gold is precious purely because people want it. It is not necessarily useful—you can't eat gold, and it won't keep you warm at night, but the majority of people think it is beautiful, and they know others think it is beautiful.
So, gold is something that has worth. Gold, therefore, serves as a physical token of wealth based on people's perceptions.
This relationship between money and gold provides insight into how money gains its value—as a representation of something valuable.
The second type of money is fiat money, which does not require backing by a physical commodity. Instead, the value of fiat currencies is set by supply and demand and people's faith in its worth. Fiat money developed because gold was a scarce resource, and rapidly growing economies growing couldn't always mine enough to back their currency supply requirements. For a booming economy, the need for gold to give money value is extremely inefficient, especially when its value is really created by people's perceptions.
Fiat money becomes the token of people's perception of worth, the basis for why money is created. An economy that is growing is apparently succeeding in producing other things that are valuable to itself and other economies.
The stronger the economy, the stronger its money will be perceived (and sought after) and vice versa. However, people's perceptions must be supported by an economy that can produce the products and services that people want.
For example, in 1971, the U.S. dollar was taken off the gold standard—the dollar was no longer redeemable in gold, and the price of gold was no longer fixed to any dollar amount. This meant that it was now possible to create more paper money than there was gold to back it; the health of the U.S. economy backed the dollar's value.
If the economy stalls, the value of the U.S. dollar will drop both domestically through inflation and internationally through currency exchange rates. The implosion of the U.S. economy would plunge the world into a financial dark age, so many other countries and entities are working tirelessly to ensure that never happens.
Today, the value of money (not just the dollar, but most currencies) is decided purely by its purchasing power, as dictated by inflation. That is why simply printing new money will not create wealth for a country. Money is created by a kind of a perpetual interaction between real, tangible things, our desire for them, and our abstract faith in what has value. Money is valuable because we want it, but we want it only because it can get us a desired product or service. How Is Money Measured?
How Is Money Measured?
But exactly how much money is out there, and what forms does it take? Economists and investors ask this question to determine whether there is inflation or deflation. Money is separated into three categories so that it is more discernible for measurement purposes:
M1 – This category of money includes all physical denominations of coins and currency; demand deposits, which are checking accounts and NOW accounts; and travelers' checks. This category of money is the narrowest of the three, and is essentially the money used to buy things and make payments (see the "active money" section below).
M2 – With broader criteria, this category adds all the money found in M1 to all time-related deposits, savings accounts deposits, and non-institutional money market funds. This category represents money that can be readily transferred into cash.
M3 – The broadest class of money, M3 combines all money found in the M2 definition and adds to it all large time deposits, institutional money market funds, short-term repurchase agreements, along with other larger liquid assets.
By adding these three categories together, we arrive at a country's money supply or the total amount of money within an economy.
The M1 category includes what's known as active money—the total value of coins and paper currency in circulation. The amount of active money fluctuates seasonally, monthly, weekly, and daily. In the United States, Federal Reserve Banks distribute new currency for the U.S. Treasury Department. Banks lend money out to customers, which becomes active money once it is actively circulated.
The variable demand for cash equates to a constantly fluctuating active money total. For example, people typically cash paychecks or withdraw from ATMs over the weekend, so there is more active cash on a Monday than on a Friday. The public demand for cash declines at certain times—following the December holiday season, for example.
How Money Is Created
We have discussed why and how money, a representation of perceived value, is created in the economy, but another important factor concerning money and the economy is how a country's central bank (the central bank in the United States is the Federal Reserve or the Fed) can influence and manipulate the money supply.
If the Fed wants to increase the amount of money in circulation, perhaps to boost economic activity, the central bank can, of course, print it. However, the physical bills are only a small part of the money supply.
Another way for the central bank to increase the money supply is to buy government fixed-income securities in the market. When the central bank buys these government securities, it puts money into the marketplace, and effectively into the hands of the public. How does a central bank such as the Fed pay for this? As strange as it sounds, the central bank simply creates the money and transfers it to those selling the securities.
Alternatively, the Fed can lower interest rates allowing banks to extend low-cost loans or credit—a phenomenon known as cheap money—and encouraging businesses and individuals to borrow and spend
To shrink the money supply, perhaps to reduce inflation, the central bank does the opposite and sells government securities. The money with which the buyer pays the central bank is essentially taken out of circulation. Keep in mind that we are generalizing in this example to keep things simple.
A central bank cannot print money without end. If too much money is issued, the value of that currency will drop consistent with the law of supply and demand.
Remember, as long as people have faith in the currency, a central bank can issue more of it. But if the Fed issues too much money, the value will go down, as with anything that has a higher supply than demand. Therefore, the central bank cannot simply print money as it wants./p>
The History of American Money
In the 17th century, Great Britain was determined to keep control of both the American colonies and the natural resources they controlled. To do this, the British limited the money supply and made it illegal for the colonies to mint coins of their own. Instead, the colonies were forced to trade using English bills of exchange that could only be redeemed for English goods. Colonists were paid for their goods with these same bills, effectively cutting them off from trading with other countries.
In response, the colonies regressed to a barter system using ammunition, tobacco, nails, pelts, and anything else that could be traded. Colonists also gathered whatever foreign currencies they could, the most popular being the large, silver Spanish dollars. These were called pieces of eight because, when you had to make change, you pulled out your knife and hacked it into eight bits. From this, we have the expression "two bits," meaning a quarter of a dollar.
Massachusetts was the first colony to defy the mother country. In 1652, the state minted its own silver coins including the Oak Tree and Pine Tree shillings. The state circumvented the British law stating that only the monarch of the British empire could issue coins by dating all their coins in 1652, a period when there was no monarch. In 1690, Massachusetts also issued the first paper money calling it bills of credit.
Tensions between America and Britain continued to mount until the Revolutionary War broke out in 1775. The colonial leaders declared independence and created a new currency called Continentals to finance their side of the war. Unfortunately, each government printed as much money as it needed without backing it to any standard or asset, so the Continentals experienced rapid inflation and became worthless. This experience discouraged the American government from using paper money for almost a century.
Aftermath of the Revolution
The chaos from the Revolutionary War left the new nation's monetary system a complete wreck. Most of the currencies in the newly formed United States of America were useless. The problem wasn't resolved until 13 years later in 1788 when Congress was granted constitutional powers to coin money and regulate its value. Congress established a national monetary system and created the dollar as the main unit of money. There was also a bimetallic standard, meaning that both silver and gold could be valued in and used to back paper dollars.
It took 50 years to get all the foreign coins and competing for state currencies out of circulation. Bank notes had been in circulation all the time, but because banks issued more notes than they had coin to cover, these notes often traded at less than face value.
Eventually, the United States was ready to try paper money again. In the 1860s, the U.S. government created more than $400 million in legal tender to finance its battle against the Confederacy in the American Civil War. These were called greenbacks because their backs were printed in green. The government backed this currency and stated that it could be used to pay back both public and private debts. The value did, however, fluctuate according to the North's success or failure at certain stages in the war.
Confederate dollars, issued by the seceding states during the 1860s, followed the fate of the Confederacy and were worthless by the end of the war.
Aftermath of the Civil War
in February 1863, the U.S. Congress passed the National Bank Act. This act established a monetary system whereby national banks issued notes backed by U.S. government bonds. The U.S. Treasury then worked to get state bank notes out of circulation so that the national bank notes would become the only currency
During this period of rebuilding, there was debate over the bimetallic standard. Some advocated using just silver to back the dollar, others advocated for gold. The situation was resolved in 1900 when the Gold Standard Act was passed, which made gold the sole backing for the dollar. This backing meant that, in theory, you could take your paper money and exchange it for the corresponding value in gold. In 1913, the Federal Reserve was created and given the power to steer the economy by controlling the money supply and interest rates on loans.
The Bottom Line
Money has changed substantially since the days of shells and skins, but its main function hasn't changed at all. Regardless of what form it takes, money offers us a medium of exchange for goods and services and allows the economy to grow as transactions can be completed at greater speeds.
If you’re interested in starting a business that will help others or improve the environment, then setting up a social enterprise could be the first step.
In the last decade, social enterprise has boomed, with a significant increase in the number social enterprise start-ups. According to recent government figures, there are more than 70,000 social enterprises in the UK, employing over two million people and contributing over £24 billion to the UK economy. Well-known examples of thriving social enterprises include: The Big Issue, Divine Chocolate, the Eden Project, Cafedirect and Jamie Oliver’s restaurant Fifteen
What is a social enterprise?
A social enterprise is a company whose core mission is to benefit and improve society. Like any business, they aim to make a profit but this is always reinvested back into their social or environmental goals. Social enterprises can be found in almost every industry, ranging from very small local projects to multi-million-pound service companies, and each may have a different legal structures.
Despite this diversity of business focus, social enterprises share a similar set of characteristics:
a clear social or environmental purpose
generate an income predominately from trading
reinvest the majority of their profits in their social mission
Other sources of funding include regional schemes and angel investors, with ClearlySo Angels, the first UK angel investor network for social ventures, launched in 2012 to provide investment and mentoring to social enterprises. HMRC tax relief schemes can also help you attract funding for your social enterprise by offering a range of tax relief to individual investors investing in new shares.
How to I set up a social enterprise?
When setting up a social enterprise there’s no one legal business structure to curtail you. You can choose the form that best suits your business and its social purpose including:
Sole trader or business partnership, which must be registered with HMRC
Limited company, which must be registered at Companies House
Charity or a charitable incorporated organization
Co-operative, which is owned and run by members for their own benefit
You can also set up a community interest company (CIC) – a limited company that operates to provide a benefit to the community they serve rather than private shareholders.
CICs must have a clear social mission and are regulated to ensure they maintain this purpose. To set up a CIC, you need to apply to Companies House with a ‘community interest statement’ that explains your business plan and create an asset lock to protect company’s assets. You’ll also need approval from the CIC regulator. Once established, a CIC must submit detailed accounts, an annual return and a CIC report each year.
Setting up a charity
Our charity solicitors are proud to help people create change in the world. There can be a lot to consider when setting up a new charity and we can support you through every step of the process.
Any prospective charity founder will need to consider: why a charity? There are pros (generally tax and business rates relief) and cons (generally enhanced regulation) which legal structure? The most common options are a trust, charitable incorporated organisation, company limited by guarantee or unincorporated association.
who will the first trustees be? You will need at least three trustees. They should all understand what their duties will be as charity trustees.
what will the charity’s governing document look like? Key points to consider include the charity’s objects, whether the charity will have a wider membership and how decisions will be made.
what activities will the charity carry out? It is important to have a plan covering what the charity will be doing from day one. You will need to provide information on your activities to the Charity Commission when you apply for charitable status.
We have advised on the establishment of hundreds of charities and we are used to working with the Charity Commission. Some charities we have established include the World Dementia Council, Vision UK and Partnership Support Group.
There are a number of alternatives to the traditional charitable organisation structure. Let’s take a closer look at some of them.
There is a lot that comes with being a registered charity. You’re most likely familiar with the traditional structure, where an organisation is registered with the Charity Commission. With this registered status usually comes the prestige and trust that the public has learnt to associate with organisations such as Cancer Research UK and the National Society for the Prevention of Cruelty to Children (NSPCC).
However, that prestige comes with extensive supervision by the Charity Commission, multiple filings in duplicate with Companies House and the Charity Commission, limitations on trustee and member benefits and a raft of potential liabilities for the trustees of a charity.
Many not-for-profit organisations may find that they do not meet the conditions to be a charity or that the restrictions involved in a charitable structure will not be suitable for them. The availability of tax reliefs will also be a critical factor in deciding whether or not to register as a charity.
There are a number of alternatives to the traditional charitable organisation structure. Let’s take a closer look at some of them:
Community Interest Company (CIC)
A CIC is a company registered at Companies House, but is regulated by the Office of the Regulator of CICs as opposed to the Charity Commission. Its constitution must restrict the distribution of its assets to its members (known as the “asset lock”) but otherwise it is subject to less regulation.This is one of the fastest growing types of social enterprise organisation. It varies from small locally based community organisations for the maintenance of community resources such as village greens to large multi-million pound turnover organisations in the health sector. A CIC cannot be a charity but is clear in the benefit it provides to the community.
Registered Community Amateur Sports Club (CASC)
This status is granted by HMRC for the purposes of tax relief on income, gains and profits on certain activities. Similarly to a charity a CASC can also gain business rate relief. For HMRC to grant this status an organisation must be able to establish that the money it holds is used to promote and provide facilities for eligible sports such as: tennis, swimming, rowing and Ultimate Frisbee.
The Charity Commission takes a dim view on registered charities that raise funds by carrying out trading activities. Their reasoning is that with trade comes risk, and by holding the assets of a charity in a trading company you are putting those assets at risk. To minimise the risk, a trading subsidiary can be used to carry out the trading activities of the charity and any profits generated will be filtered back up to the charity. The charity’s assets are protected from being used to meet the debts and liabilities of the trading subsidiary, even if it becomes insolvent.
Support for existing charities
Many organisations wish to raise funds for a charitable purpose but are not themselves charitable in nature. An example of this would be where a professional services firm has a list of charities chosen by its directors or employees that it supports by raising funds through events organised and sponsored by the firm. Donations can be structured in a tax efficient manner by using tools such as GIFT AID
Community Benefit Society
The aim of these organisations is to conduct business for the benefit of their community. This alternative differs greatly to all of the above, as it is an organisation formed and regulated solely by the Financial Conduct Authority. The entity is governed not by the Companies Act 2006 or the Charities Act 2011 but by the Co-operative and Community Benefits Societies Act 2014. Due to this fact, these organisations are highly specialist in nature and can be very expensive to set up and maintain.
Case studies of insider fraud in charities
These case studies cover a sample of scenarios of fraud committed by employees or volunteers in the charity sector.
Insider fraud is committed by someone involved with the charity, whether a trustee, an employee or volunteer. Themes of these anonymised case studies about insider fraud include poor or non-application of financial controls, low fraud awareness and excessive trust or lack of challenge.
The actions taken by the charities demonstrate that relatively straightforward, positive steps can be very effective in strengthening fraud resilience
Fraud by a charity employee
The charity’s office co-ordinator defrauded charitable funds to a value of over £45,000.The fraudster was responsible for paying charity bills but was not an authorised signatory on the charity’s bank account. The fraudster was able to access one of the senior management team’s bank account login details to set up fake payees’ in the name of genuine third parties. The funds were then transferred to the fraudsters own bank account.
Bills were then falsified and the fraudster used the bank login details to authorise the false bills. When the charity conducted its weekly bank account checks they showed trusted partners being paid, although in reality these were false payments to the fraudster’s personal bank account.
The fraud was carried out over a period of 6 months and was only detected when the fraudster admitted it.
The charity’s bank was contacted to stop the false payees and the fraudulently accessed login details. An internal investigation was carried out on the charity’s bank account and its transactions to establish the full extent of the fraud. All payments were reviewed during the period that the fraudster was employed.
The investigation also considered the potential for wider collusion. Appropriate reports were made to the relevant authorities, including the Charity Commission and the police.
Fraud by a charity finance director
A finance director defrauded a charity of over £900,000 over a 7 year period, which only came to light after the director had been made redundant.
A review of the charity’s transactions revealed that amounts paid through one of the charity’s accounts did not match the amounts the charity had been invoiced for. The director had attempted to cover tracks by making false journal entries in the charity’s accounts system.
Initial investigations revealed that the director had misappropriated over £200,000 of charity funds in the last 12 months. The charity also widened its investigation to include transactions made in earlier years.
The director had no access to the charity’s finances or bank accounts after leaving the charity. The investigation concluded that no further fraudulent losses were carried out after the director left the organisation. The charity reported the fraud to the police and its banking providers, and trustees were fully informed of the situation and investigation.
Lessons learnt and outcomes:
A new finance committee was established, which meets every month. The committee included the chair of trustees and two other trustees, one of whom is a qualified accountant. A new online accountancy package was also purchased. This had the capacity to limit access to read-only for individuals who do not need full access.
The charity re-wrote its financial procedures manual, addressing previous weaknesses, and relevant staff were trained to use it. The charity’s ex-director was convicted of 2 charges of fraud and was sentenced to 6 years imprisonment.
Fraud by an employee of a partner organisation
A field supervisor from a partner organisation of a charity, working on an aid programme in Niger, dishonestly took charity funds totalling £46,000.
The charity funds were fraudulently diverted as a result of deliberate overpayments for goods and records showing payments that beneficiary groups did not receive. False purchases had also been charged to the charity programme.
There was insufficient oversight by the charity of its partner organisations’ field supervisors. This made the charity vulnerable to fraud.
Fraud by a charity chair
The chair of a Parents Teachers Association (PTA) defrauded the charity of over £35,000 over 4 years. The fraud was discovered following the appointment of new trustees who uncovered financial irregularities.
When new trustees joined the charity they discovered that there were no financial controls in place, including no recording of money raised at fundraising events. Funds raised by the charity were also not forwarded to the school at regular intervals.
Lessons learnt and outcomes:
Having weak internal financial controls and procedures made this charity susceptible to insider fraud. By strengthening these procedures and processes they are reducing the risk of this happening again.
The previous chair of the charity was convicted of 5 counts of theft. The person was sentenced to 2 years in jail, suspended for 2 years, plus 300 hours of unpaid work.
£20,000 of the stolen money was paid back to the charity.
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The truth is out: money is just an IOU, and the banks are rolling in it
The Bank of England's dose of honesty throws the theoretical basis for austerity out the window Back in the 1930s, Henry Ford is supposed to have remarked that it was a good thing that most Americans didn't know how banking really works, because if they did, "there'd be a revolution before tomorrow morning".
Last week, something remarkable happened. The Bank of England let the cat out of the bag. In a paper called "Money Creation in the Modern Economy", co-authored by three economists from the Bank's Monetary Analysis Directorate,
they stated outright that most common assumptions of how banking works are simply wrong, and that the kind of populist, heterodox positions more ordinarily associated with groups such as Occupy Wall Street are correct. In doing so, they have effectively thrown the entire theoretical basis for austerity out of the window.
To get a sense of how radical the Bank's new position is, consider the conventional view, which continues to be the basis of all respectable debate on public policy. People put their money in banks. Banks then lend that money out at interest –
either to consumers, or to entrepreneurs willing to invest it in some profitable enterprise. True, the fractional reserve system does allow banks to lend out considerably more than they hold in reserve, and true, if savings don't suffice, private banks can seek to borrow more from the central bank.
The central bank can print as much money as it wishes. But it is also careful not to print too much. In fact, we are often told this is why independent central banks exist in the first place. If governments could print money themselves, they would surely put out too much of it,
and the resulting inflation would throw the economy into chaos. Institutions such as the Bank of England or US Federal Reserve were created to carefully regulate the money supply to prevent inflation. This is why they are forbidden to directly fund the government, say, by buying treasury bonds, but instead fund private economic activity that the government merely taxes.
It's this understanding that allows us to continue to talk about money as if it were a limited resource like bauxite or petroleum, to say "there's just not enough money" to fund social programmes, to speak of the immorality of government debt or of public spending "crowding out" the private sector. What the Bank of England admitted this week is that none of this is really true.
To quote from its own initial summary: "Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits" … "In normal times, the central bank does not fix the amount of money in circulation, nor is central bank money 'multiplied up' into more loans and deposits."
In other words, everything we know is not just wrong – it's backwards. When banks make loans, they create money. This is because money is really just an IOU. The role of the central bank is to preside over a legal order that effectively grants banks the exclusive right to create IOUs of a certain kind, ones that the government will recognise as legal tender by its willingness to accept them in payment of taxes.
There's really no limit on how much banks could create, provided they can find someone willing to borrow it. They will never get caught short, for the simple reason that borrowers do not, generally speaking, take the cash and put it under their mattresses; ultimately, any money a bank loans out will just end up back in some bank again.
So for the banking system as a whole, every loan just becomes another deposit. What's more, insofar as banks do need to acquire funds from the central bank, they can borrow as much as they like; all the latter really does is set the rate of interest, the cost of money, not its quantity.
Since the beginning of the recession, the US and British central banks have reduced that cost to almost nothing. In fact, with "quantitative easing" they've been effectively pumping as much money as they can into the banks, without producing any inflationary effects.
What this means is that the real limit on the amount of money in circulation is not how much the central bank is willing to lend, but how much government, firms, and ordinary citizens, are willing to borrow. Government spending is the main driver in all this (and the paper does admit, if you read it carefully, that the central bank does fund the government after all). So there's no question of public spending "crowding out" private investment. It's exactly the opposite
Why did the Bank of England suddenly admit all this? Well, one reason is because it's obviously true. The Bank's job is to actually run the system, and of late, the system has not been running especially well. It's possible that it decided that maintaining the fantasy-land version of economics that has proved so convenient to the rich is simply a luxury it can no longer afford.
But politically, this is taking an enormous risk. Just consider what might happen if mortgage holders realised the money the bank lent them is not, really, the life savings of some thrifty pensioner, but something the bank just whisked into existence through its possession of a magic wand which we, the public, handed over to it.
Historically, the Bank of England has tended to be a bellwether, staking out seeming radical positions that ultimately become new orthodoxies. If that's what's happening here, we might soon be in a position to learn if Henry Ford was right.
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Photos by Pixabay.com