The current global financial system has many fundamental flaws but very few seem to focus on them. The recent financial crisis that played havoc with socio-economic and political systems of the world especially highlighted these flaws. Among them, money issue is the elementary but rarely discussed problem despite the fact the money is the basic unit of the finance. Unfortunately, the underlying mechanism of its creation and distribution is misunderstood or not discussed at all.
The Concept of Money:
It is pertinent to understand the concept of money or why do we need it.
- We need money to have a common unit to measure the prices of goods and services.
- Money is the physical (or electronic) representations of that unit to exchange goods and services.
However, it is important to remember that:
- Money itself has no intrinsic value.
- The money is created only as measure of value and medium of exchange.
- Money is a mean to achieve a certain objective i.e. purchase of goods and services, and not the objective itself.
- Therefore money’s eventual purpose is ONLY exchange of goods and services.
Money and Interest:
In the context of above discussion, it is also imperative to discuss interest and its drawbacks.
- One of the major drawbacks of the interest is that it makes people convert money into a commodity itself by holding on to it. In realty, money is only a voucher which enables people to buy something. The interest creates significant distortion in the economy because it allows people to earn money on just money without adding any value to the wealth.
- Similarly, interest also discourages people to make an effort or take a risk for undertaking or participating in real economic activities for earning.
Asset-Liability Tenor Mismatch:
Asset and liability tenor is the main method banks use to earn money. In this method, banks take money from the depositors with the promise of giving interest and undertaking that they can withdraw money at any time and lend it again for longer times at higher interest rate. However, this system relies on big assumption that only a small percentage of depositors will withdraw the money.
Depositors usually have no idea where their money goes or how they get interest. They only raise an eyebrow when the bank is caught in any financial or other trouble.
The Global Financial Crisis:
Few years back, the world suffered from one of the worst financial crisis of recent history and various countries are still struggling to recover from it. Following are some of the reasons why this crisis hit the world.
- Individuals and economies are addicted to debt.
- The greed of getting more and more profit on easy investments.
- Outrageous compensations to investment bankers and brokers which always look for short term gains.
- The credit itself was a big problem which was further aggravated by credit crunch.
- The so called solution of pumping in more credit made the situation even worse.
- However, the organisations which relied more on equity than debt managed to somehow wither the storm relatively easily.
Uncontrolled Currency and Socio-Political Issues:
There are many other reasons countries struggle economically.
- Governments often use the uncontrolled issuance of currency to cover for their deficits.
- This has long term adverse impacts. Causes undue inflation – which is confiscation of real wealth.
- Also, with uncontrolled currency issuance, unlimited debt can be issued – which creates further inflation.
- Governments try to find short terms problems of their economic problems rather than finding long lasting and better ways of handling them.
- Inflation’s adverse impacts are far more severe on the poor than on the rich.
- The greed during Booms and the harm during Busts including job losses are much more devastating for the poor.