Money Matters?

Imagine! If a firm offers its shares as your only salary, will you accept? None on this earth with true sense will accept however extraordinary the firm might be! Reason being, even if you wished to get yourself a toothbrush, you would need an instrument, what is known to all of us as a ‘currency note’. The shopkeeper does not accept any other instrument other than a ‘currency note’. CN remains as the preferred instrument for all transactions, which is nothing but an agreement paper between two parties that party X is willing to pay party Y, a sum of XX rupees.

Now, is it not a paper, which has a value of cost of production of the note itself? Is that an employee is worth just a bunch of papers for his month’s work? Is that the value of his work? Since the retailer is comfortable in getting a CN for exchange of a toothbrush, we do not complain. Imagine! Out of wild dreams, that the annachi shop refuses to give you toothbrush for a piece of paper (CN). He demands a 50mgm of gold as he feels the demand for it has been on rise. Remaining still in the dreams, this is the only shop in the city where you will get a toothbrush. We do not have a choice! We would give him a 50mgmof gold for exchange of a toothbrush. Now, the problem is I have to store gold at home and carry it every time for purchase of a toothbrush, once in a month. It’s a problem. So I cut a deal with him saying that I would write an agreement note saying that I owe him 50gms of gold, every time I bought toothbrush from him. I would handover that agreement note instead of physical gold during every purchase and would once a year settle his gold due upon receiving all the agreement notes. Now coming out of dream, in today’s world this agreement note is what is termed as the CN. Since everyone trades in CN (ie, you receive agreements-CN from your employer and give it to your retailer for exchange of goods and goes on) no one is asking for his settlement of gold at the end of year. The principle is that the underlying asset for CN is gold. The value of CN is determined by the gold.

Going back to dream world again, if I had only 10 gms of gold I cannot issue CNs worth more than 10 gms for anyone in a month. Now that is what is called as Cash Reserve Ratio (CRR) in today’s world. Every country maintains a certain minimum level of gold as underlying asset (Recall: previous para) for printing and issuing currency notes. For example, India would maintain 100 kg of gold in its treasury, to print and issue 50 crore of rupees into market. Similarly, banks need to maintain minimum amount of rupees to issue a certain amount of loan. For example, North Indian bank has to maintain 10 Rs in its account to issue 100 Rs worth of loans. The 10 Rs, moreover the 10% is called as CRR. The frequent increase in CRR we hear in news happens when government wants to strangle the supply of money. By increasing CRR, banks are forced to maintain higher money in its account to give the same amount of loan. Hence it can offer only less number of loans, thereby decreasing money supply in market. This is a strategy used at times of high inflation, which requires cut down in money supply. So, the humans have created a magic! They have created something out of nothing! Created money out of nothing! Now, we see the same trend in gold ETF and stock/commodity futures. The underlying asset for gold and stock/commodity futures is the gold and stock/commodity by itself. So as time passes by, man could be using just the ETF and futures for trading, forgetting the actual underlying asset. This is similar to man forgetting gold as the underlying asset for CN and still using CN as the trading instrument. So who knows, be prepared to use a commodity future or a gold future to buy a toothbrush in the future!!