So how is it that these big corporate
houses run by the likes of Vijay Mallaya and Nirav Modi are able to get loans
which are beyond their reach, loans for plans which don’t even make business
sense and eventually commit and get away with financial frauds worth billions
of dollars.
In my opinion, most of us don’t understand
the concept of modern banking. But before we try and understand money and banking,
we must understand the system which existed before it.
Brief History of Money
Money is known to be the most efficient system of mutual trust, universally. It enables us to cooperate effectively in trade and industry. But money is essentially a medium of exchange and is based on the principle of trust. Even today, the currencies around the world mention ‘guaranteed by central bank’. After many experiments with barter systems and then precious metal coins, the invention of paper money came into existence in the 17th century in France. As the number of transactions between humans increased we invented paper money which was easy to carry around and transact with.
Money is known to be the most efficient system of mutual trust, universally. It enables us to cooperate effectively in trade and industry. But money is essentially a medium of exchange and is based on the principle of trust. Even today, the currencies around the world mention ‘guaranteed by central bank’. After many experiments with barter systems and then precious metal coins, the invention of paper money came into existence in the 17th century in France. As the number of transactions between humans increased we invented paper money which was easy to carry around and transact with.
Global Currencies: After the end of WWII
when America established its supremacy over the Europe, the US dollar was
chosen to be world’s reserve currency which gave birth to the gold standard. The
gold standard required all major currencies to be tied to the dollar at a fixed
rate and because most of the gold was held in the US vaults the US dollar was
backed by gold at a fixed rate of $35 per ounce. However, the gold standard
system only lasted for 25 yrs and was abolished by US president Nixon in 1971.
Fictional Money
Fictional Money
With this move no currency was backed by
anything of value, which in turn gave birth to FIAT currency. FIAT an Italian
word which means a currency by force or authority, a currency which is represented
by legal tender and is backed by nothing except government promise. So
government had the right to create money out of thin air and people have no
choice but to accept it, which gave rise to problem no. 1-
In order to raise funds (in case of fiscal
deficit) the governments resorted to printing money and issuing unlimited amount
of money with only government bonds or securities backing it. So in India for
example RBI is a prime buyer of bonds as it
prints money and buys these bonds which increase the money supply through which
government’s deficits are financed.
The 2nd main problem is the fractional
reserve banking system, which is the basis of banking across the world.
FRB is a system where the bank is required to maintain only a fraction of the
deposit liabilities, which means, that the bank can effectively maintain a
balance of lets say only $10 and lend $100, invest, give loans and also earn
interest on it. According to FRB system US and India have to maintain a 10%
reserve ratio.
So imagine, money which gets printed out of
nothing by the central bank can further be lend at rate fixed by the central
banks and the retail banks can profit from it. It might sound like a joke but that’s
how most of the banking across the world operates. Infact some countries like
the UK, Canada, Australia don’t have any reserve requirement. Also imagine if any
ordinary person was to print money like this, they would be jailed for doing so,
but not the government. There are ofcourse other major hazards to this system, one
of them being- In case all its depositors ask for their money back, the bank
will go bankrupt instantly. In other words, all banks actually for all
practical purposes are BROKE, as the banks have only 10% as reserve and
cant afford to return all its depositors back at the same time.
The Crony Capitalism
The Crony Capitalism
So how has this scandal been going on for
so long? Well we all have a role of play in it, but majorly it is backed by the
politicians and the central bank which obeys the order of the government. So
for instance many governments across the world raise funds for infra projects
from central bank by simply printing it. And in case the projects fail, or are
delayed or the banks go bust due to NPAs, the tax payers picks up the tab for
it. Yes thats u an me. Paying taxes and getting penalized for this reckless
game which someone else is playing. But like I said we too have a role to play
in it and it’s a vicious cycle. This easy credit is usually given out to
businesses to spur economic growth, without (the so called) growth, economics
will not prosper and if economies don’t prosper the politicians will be voted
out of power. Over the last decade the banks and the government have been
frenziedly printing money pumping in cheap credit into economics. As a result,
countries are sinking their economies into big debt traps e.g. the US had $21
trillion debt in 2017, which was 92% of its GDP. Japan has the highest debt at
255% of its GDP.
So is it really surprising that the likes
of Vijay Mallaya and so many others get away with the easy money handed out to
them as part of this reckless and vicious cycle. Some also blame it on ‘crony capitalism’ where
business houses fund politicians and the politicians pay the business men back.
In short, the powerful RIG the system in their favor till the time they are not
caught red handed.
Consumerism, capitalism and our human greed
is making this cycle even more vicious and no politician seems to be having a
solution for it, even politicians with good intend. We too are the victim of
the system because of our own ignorance. On the other hand, people who
understand it, inside out, they rig the system and rule over the ones who don’t
really understand it.
Future of Money
Future of Money
So what does the future hold for us?Is
there no hope for the ordinary citizen? Or are we trapped in own creation?
Its difficult to predict the future but till the time central banks
are controlled by the governments, its will not be easy to get out this
trap. However, the future might be a ‘bit’ different. Technology can be the game changer. For example
BITCOIN, which is a payment system and currency in itself. Bitcoins are completely virtual coins designed to be
‘self-contained’ for their value, with no need for banks to move and store the
money. Bitcoin cannot be created out of thin air, and
is free from any government interference. Bitcoin is also based on trust as the
transactions are constantly verified by minners.
In short, the future of money and
transactions is at the threshold and will surely change as the pressure on the
monetary system increases and the debt levels in countries mount. The money
market too is likely to experiment with many forms of currencies. In Israel,
for example, there are some 87 alternative currencies that can be used for
various transactions.
One thing is for sure that the traditional form of banking controlled entirely by the central banks and the government is on its way out. People will demand for more transparency and higher accountability for their money from the governments so that Vijay Mallyas of the world are not able to rig the system and get away with it so easily.
One thing is for sure that the traditional form of banking controlled entirely by the central banks and the government is on its way out. People will demand for more transparency and higher accountability for their money from the governments so that Vijay Mallyas of the world are not able to rig the system and get away with it so easily.
Something highly disruptive is on own its
way in next 5-10 years, are we game??
