MODULE 4: Money, Lesson 7
How Money Works
Adnan Ul Haq
How Money Works
Adnan Ul Haq
Money - It’s something we all desire, but few of us understand. While it might seem boring, once you learn how money works, you will have a complete understanding of how you can utilize it to buy things in your everyday lives.
So let us begin towards the cycle of money.
Money is a Tool
Money can be used as a tool, but it has no other purpose or meaning to it. Money is simply a means of trade.
It makes perfect sense that a good tool can help you do your work better. If a tool is defective, however, it might spoil the fun of doing the job. Similar is a case with the money it is effective and defective at the same time.
A dollar is more useful than a rupee in today's world because the dollar keeps its value while the rupee's value keeps going down.
Money Comes From Government
Second, you will need to understand where the money comes from. It is printed by the government. When governments print more, the value of money is decreased; and when it is printed less, its value increases.
Once we put money in money, i.e., we keep on saving money, the value of it will eventually drop, and our money will lose its importance. That is why we are not putting our money in money but in assets that will store value.
Demand and Supply Set Prices
To understand the price of goods, you must first understand the demand and supply of money. Demand for money is created by the rate of interest. The rate of interest is set by the Federal Bank. The supply of money is created by the creation of new dollars in circulation. This can be changed by printing more money.
Why are things sold at different prices in the shop?
Because of two things.
- Firstly, how much is that thing produced itself and how much is it in demand? This will set its price.
- Secondly, the amount of money in the economy, that is, the amount of money printed by the government the demand and supply of this will set its price.
Increasing Prices Reduces the Value of Money
If more money is printed, the price of goods will increase. If less money is printed, the price of goods will decrease because money loses value as it is printed. This means that if the government prints more money, prices go up, and your income stays the same. Your 1 lac rupees stay the same, but if the government prints money, your 10 lacs will not be enough to buy things you need.
Now that you have understood what money is and where it is coming from, let us explore more about it.
When Does the Government Print Money?
Following are the phases when the government prints money and its value start depreciating:
Incompetent to Pay Debt
The first reason that the government might print money is that it can't pay back a loan. In the winter months, when people use more electricity, it takes out another loan. And when it can't pay that back, it prints money to repay the first one.
Incompetent to Collect Tax
Without taxes, the government would have to print money to make ends meet. The printing of money often leads to inflation or, as in addition to inflation, a tax is imposed on everyone. Inflation is when the value of your money decreases just by sitting in the bank.
Incompetent to Meet its Budget
The government sometimes has trouble balancing its budget. It tells us what it hopes to spend money on and what it hopes to collect in taxes, but sometimes the expenses are higher than expected, and the government needs to print more money.
For Development Purposes
Expenses are bound to be a part of life. The government will print money to pay for bridges and other things they would like to build.
Now the question is, how does debt create money? We will also explain this to you.
Debt Creates Money
To create money, the government provides debt. It gives this money to the people who buy the bonds. The banks make it possible to borrow more money than there is money available by giving out loans many times larger than what they have on deposit. This provides a lot of buying power for everybody who can pay it back.
When everybody gets buying power, what happens? Your prices rise. Your money decreases just by being kept in the bank.
Money Changes Hands
Money changes hands when it's spent. Today, you have it. Tomorrow, I'll have it. Then, someone else will have it. So, the spending of money you talk about is really the change of hands that happens when people buy things.
The spending comes round to you again. The income of one person is spent by the next one. This means that if you’re spending, it gets back to you as well. And when money changes hands, the wealth of people move from one to another.
When money changes hands, we do two things. It becomes an asset for one person and liability for another. It becomes a liability for the person who gives it away because he has to work hard to earn more, and it becomes an asset for the person who receives it because he can spend it freely.
Wise People Make Assets From Money
Smart people turn their money into assets. They invest it in stocks and bonds, not in unnecessary luxuries. Foolish people see money as disposable income. They spend it on frivolous things.
What happens to assets?
Assets grow in value and appreciation. They increase your wealth. Liabilities are debts expenses. They are things that cost you money that you have to pay in the future to someone else. This only leaves you with less money and means that you will have less money to spend or invest next year or some years down the line.
There are types of assets, so you have choices to buy your type of asset.
Types of Assets
There are two kinds of assets in a broader category. We will explain both in detail for your better understanding.
Cash flow assets are those assets that bring in money to you on a monthly basis. For example, you buy an apartment or a building and receive a rental income on it every month. This is a cash flow asset and will build your wealth.
Cash flow assets make you money in two ways.
- One, they appreciate in value over time, so that if you buy an apartment for 1 crore, it will increase in worth to 2 crores.
- Secondly, you can receive rent checks from the apartment every month.
Non-cash flow assets are those assets that will not generate any income. You will not see any money coming in from it, for example, gold.
And, often, a non-cash flow asset either appreciates or depreciates in value. We won't call it depreciating assets yet, but they do hold value, as gold is a tangible asset whose price can appreciate. When the value of money decreases, gold's value will increase. However, it won't earn you any income. You have a plot of land, and it will not earn you rental income, but its value will appreciate.
Remember, you are always going to spend your money wisely. Instead of spending your money, you are going to spend on smart investments. After all, you can't make more money if you don’t make the most of what you already have!