Basic financial literacy, part 1: What is money? Two types of money

money, week 14

What is money?

Money rules the world today, that is an indisputable fact. Money, money and money again. We either own money or we spend our whole lives wasting it. But what exactly is money and how is it created?

Two types of money

Every modern economy is based on money with so-called forced circulation, which is called fiat money. It is money issued by central banks. This money has no value because the paper used to make it is essentially worthless. Even so, this fiat is used to exchange services or goods because people simply trust the central bank to maintain their stable value. However, should central banks fail, fiat money would cease to function as a medium of exchange and lose its appeal as a store of value.

In every modern economy, there are two types of money – classic money (paper) and electronic money. Electronic money is one of the most frequently used money today. There is probably no need to explain why this is the case. Paying with electronic money is simply more convenient. And what exactly is electronic money? It’s simply a set of numbers you see in your bank account.

If we think about the difference between paper and electronic money, it is clear that it is completely insignificant or even non-existent. For example, when you buy a TV at an electronics store, it doesn’t matter if you pay for it in cash or with your credit card. The price of the goods will not change and will remain the same. In this case, it is only a matter of comfort or preference.

This article could also interest you: Ever wonder where all the printed money ends up?

The emergence of money

A noticeable difference between paper and electronic money only appears when they are created. Paper money is issued by national central banks in the form of paper notes or coins. Do you also think that central banks spend most of our money? Error. In fact, this money issued by central banks represents only 3-5% of the total money supply.

The rest belongs to electronic money created by commercial banks. If you think that electronic money is just an electronic version of paper money, you are wrong. Electronic money is created by commercial banks when these banks issue loans. However, the idea that there are thousands and hundreds of thousands of small savers who have put this money into the bank and that the bank is now using it is completely wrong. The bank simply creates a certain amount out of the air and adds it to the total money supply in the given economy. And so those 95-97% of the total money supply is created.


In conclusion, it is really a bad idea to let banks, these private institutions, make money and control them. The only entity that really benefits from this system is the bank itself. Banks can cancel ATMs, do not have to hire new people and do not have to buy transport vehicles for cash transfers. The result is lower costs for banks and especially huge profits.

Many people today still live in the belief that banks lend money to their depositors. However, this is not really the case. The fact that banks make money out of nothing has been confirmed, for example, by the Bank of England:

“Commercial banks create money in the form of bank deposits by issuing new loans. For example, when a bank lends to someone who takes out a mortgage to buy a house, it usually does not do so by giving them thousands of bills. Instead, he will credit their account with the value of the mortgage. ”

And this simple spell will create completely new money.

Our next chapter will be about brief history and development of money.

Leave a Reply

Your email address will not be published. Required fields are marked *