Where does the money come from, and who controls it?
There are two main ways money is created:
- centralized,
- decentralized.
The centralized method is how our money is issued: dollars, euros, pounds....
Usually, a country's national Central Bank is in charge of issuing money. The central bank can create money by buying government bonds or assets from commercial banks.
In most countries, this is done by the national bank, which sets the rules for issuing money and controls the money supply in the economy. The central bank can increase or decrease the money supply depending on economic conditions and the goals it sets for itself.
In some cases, a country may choose not to establish its central bank and allow domestic circulation of any other currency, usually one of the reserve currencies: the U.S. dollar, the Euro, etc.
However, the independence of central banks is usually ensured by legislation. In some countries, legislation may stipulate that the central bank governor must be appointed for a fixed term and cannot be dismissed early. There may also be rules that limit the government's ability to interfere with the central bank, such as restrictions on printing money without the central bank's approval.
A decentralized way of creating money is associated with cryptocurrencies. In the case of decentralized issuance, money is made through the operation of computer systems and algorithms that keep the network running and has no central governing body. The most famous examples are Bitcoin and Ethereum. Their issuance was programmed at creation and is maintained automatically by the nodes of the network that want to work with the cryptocurrency.
Who controls the issuance of currency, and how?
Central banks control the issuance of currency. They determine the amount of money that can be put into circulation. This is done by setting rules for issuing money, defined by legislation and regulatory bodies.
The money supply is also controlled through reserve requirements. Commercial banks must keep a particular portion of their deposits with the central bank. This allows the central bank to control the money supply, as an increase in reserve requirements reduces the amount of money available for lending at commercial banks.
When new money enters circulation, it can cause prices to rise. This is because an increase in the money supply leads to increased demand for goods and services. If supply cannot meet demand, prices start to rise. Therefore, you can't just print more money — it will quickly depreciate, and there will be no point in such an operation.
Who determines the value of a currency?
There are two types of exchange rates:
- floating,
- fixed.
In a floating exchange rate system, the price of currency is set in the market based on supply and demand. In a fixed exchange rate system, the currency price is set by the central bank, which guarantees the stability of the exchange rate.
In most countries, currency rates are determined by supply and demand in the currency market. If the demand for a currency is higher than the supply, its exchange rate rises. Conversely, if demand is lower than supply, the rate falls.
There are several ways to stimulate the demand for currency:
- Balancing exports and imports of goods and services. When exporting, companies receive payments in foreign currency, which they can exchange for the local currency, thus strengthening its exchange rate against the currencies of other countries.
- Foreign investment. Investors from other countries can put their money into the country's economy, resulting in foreign currency inflows and improved economic performance.
- Tourism. Tourists visiting the country can exchange their currency for local currency, increasing its demand.
All of the above tools, as well as many others, can bring finance into a country's economy and affect the exchange rate of the local currency.
Although most countries use a floating exchange rate, some use a fixed one. For example, Hong Kong pegs its currency to the U.S.U.S. dollar, and China uses a fixed exchange rate for the yuan. This means that the central banks of these countries are committed to selling and buying currency at a fixed price.
A fixed exchange rate is an exchange rate set by a central bank and remains unchanged for a certain period.
However, a fixed exchange rate can lead to the creation of black markets for currency. If the real exchange rate differs markedly from the central bank's fixed rate, people may try to sell the currency directly, bypassing the country's official banks.
Ultimately, this can lead to unofficial currency trading and the creation of illegal markets, which may even involve criminal activities such as money laundering.
In addition, if the central bank cannot maintain the necessary supply and demand at a fixed exchange rate, it can lead to devaluation of the national currency and economic problems in the country.
And we wrote about cryptocurrencies: Who sets the price of bitcoin?
Summary
The monetary system is an essential element of the financial system and is vital for the economy and society.
Central banks control the issuance of money, and the financial system is regulated through various governing bodies.
Exchange rates are determined by supply and demand in the foreign exchange market, and the exchange rate type can be floating or fixed, depending on the country.
