Well, the first time I got to know how Money just comes into existence out of "Nothing", I could only draw parallels with an equally bizarre explanation called the "Big Bang theory" where Physicists would like you to believe that there was a big bang from "Nothing" some 13.8 billion years ago, and lo and behold we had everything that you see today emerge from it. The spurting into life of new Money in this fiat monetary system has similar background. OK, let me take an example and explain.

Well lets assume you have a 1000 rupees to credit into a bank account. Now, the questioning Tom's amongst you will be thinking, where did this 1000 rupees come from? Well, let's just say it already exists and you wish to invest in a bank account. Now, this 1000 rupees is a liability for the bank, and an asset for you. Now, the Bank does not make money by just holding onto this money in their account. They have the legal right to take a large percentage of this money (technically close to 100%), and loan it to their customers. In this case, let us say that they retain 100 rupees and loan away 900 rupees to another one of their customers. Now, this customer takes this 900 rupees and credits it to his account which could be the same Bank or some other Bank. Now, all of a sudden a new 900 rupees becomes available for the Bank to again credit say another 90% to some one else. Thus flows the chain of credits and debits, and eventually you will find that an original cash of 1000 rupees has resulted in a net chain of 10,000 rupees worth of money flowing across this system. At any given time, the banks in this transaction chain will have only the initial 1000 rupees available with them, the rest being loaned out. Hence, this chain becomes functional as long as there are no defaults by any of the debtors, or as long as all creditors don't land one day at the banks door and start demanding closure and full payment of their money.


Now, this is a case where money just multiplies in the system, but this is not a case of the Big Bang, where money just appears out of thin air. For that we need the Government of India and the Reserve Bank to conjure up the magic. Well, the Government of India or GoI has the legal authority to create what is known as the Bonds. Basically, this is a piece of paper which says, I owe You (IoUs) so much money at so much interest. After making up this paper it gives it to the RBI, which then magically creates the money, yes you read it correctly, creates this money out of thin air. RBI has the powers to do this, and thus is born new money which is basically new debt. Hence, we can conclude something from this whole exercise, new money in a fiat economy equals new debt. Hence, the whole system is based on a policy of expanding  debt, and every year, this debt or money flow has to increase at least by an amount so that the interest payments on previous debts could be serviced.

Well, there you have it. What you consider as precious money is just nothing but a bunch of IoU's that has to be serviced by the Government, and hence by YOU or your next generations. Well, the government and our political class can have a grand party at the cost of our pain and sweat. If they goof up in this debt based economy, the repercussions of their party is to be borne by the working classes like you and me. Now, in the midst of all my explanations above, I have not mentioned about the holy grail amongst all these chain of credits and debits. Unless this particular aspect exists, then there will be no love lost at all between the banks and their debtors is it not? Yes, you have guessed it right. It is the interest you earn for your investments and the interest you have to pay for your loans. The Banks, in this whole process of loaning and taking new credits, earn because of the differential that exists between the rate at which they pay you interest for your investments and the rate at which they will loan you the same amount, which is always going to be higher.

I hope you have gained some understanding on what Money really is from the this and the previous blog that I have written, and how it assumes value in this fiat economy. Now, if you need to retire and do it while you still have your teeth around, there is an important concept that you need to understand which will be my next blogging topic - "Inflation". So adios friends, and wish you all a very happy New Year (2014).