Currency is not money. Currency is a medium of exchange that can be used to purchase something that has value, called an asset. Throughout the ages human-beings have been treating livestock, grains, spices, shells, beads and paper as forms of currencies. People who engaged in trade had to process their transactions by carrying the items they buy and sell. This was known as Barter system. It was also called "carrying out a trade". If someone with 5 cows wants to buy 20 hens, he has to carry them to the buyer’s place and exchange them. This includes many drawbacks like transaction costs, shoe leather cost – which includes cost of time and effort, bargaining costs, problem of divisibility- that is we can’t sell half a cow if we need to buy hens. So this leads to highly inefficient payment system. Currencies had not involved till then.
Gold and silver have been the predominant currency for 4500 years, but they became money in Lydia, in about 680 B.C. when they minted into coins of equal weight in order to make trade easier and smoother. Gold was known for its value among other metals at that time and so they used gold coins for trading purposes. Since gold has intrinsic value if it traded in commercial market this may lead to inflation. Till then Rs./$/pounds were not introduced.
Later Representative Money came into scene because of the inconvenience of the traders to carry heavy gold coins. Then government ordered people to surrender the gold coins and equivalent papers were issued to them. During 19th and 20thcenturies, the majority of currencies were based on the representative money. One can have enough paper money to go for a jolly trade, like how we have plastic cards in our wallets now. When the world was on the classical Gold standard, there was no inflation. Currency was real, and it was verifiable money, meaning that there was actual gold and silver in the treasury backing it up.
But to fund the wars, the costliest of human endeavours, Governments replaced representative money with currency (Fiat money) that can be printed in unlimited quantities. World was following the gold standard slowly. As per Federal Reserve Act of 1913, Federal Reserve has to keep a 40% reserve of “lawful money” (gold) at the US treasury. Generally if we give $20 dollars of gold they have to give us $20 of money in return in this case there will be no inflation. But when we give $20 gold they give us $50 of money as a 40 % reserve. And when this is given to foreign banks and commercial banks uses “Fractional Reserve Banking”. This allowed banks to maintain a certain amount of currency on hand for withdrawals and loan out multiples of the amount. Say, 10% is the reserve requirement set by the Federal, a bank must keep 10% of the currency deposited and can loan out 90% of those deposited. This means if $20 Gold is in vault, Federal could put $50 in circulation. Then banks could create loans of more dollars, which will result in circulation of more money and reduction in the resource “GOLD”.
Imagine if one fine day government asks us to exchange papers for gold, there will a huge crowd with lot of money in a long queue only first few will get gold. What will happen to others?? At that time there will no value for money. There will a burst in the bubble so that the situation will change like the burst in the “Tulit Bulb” bubble situation. It may happen anytime anywhere. Anything in abundance will lead to blow up the big bubble. This is what the present scenario and this is the fact everyone should know to balance the crisis.
