A Mystery Well Worth Unraveling

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What is money? Since when have we been trusting what literally is only a printed piece of paper as something that has a specific value? What made banks come into existence? What led to the formation of the first central bank? What roles do banks, central banks and governments play in the business cycle and in inflation? These are some of the questions that The Mystery of Banking attempts to answer.

The book starts with a basic explanation of what money is, its origins and its evolution, and briefly touches on the basic economic concepts of demand and supply of goods and money. As the book progresses, it argues, on the basis of the basic tenets it initially puts down, that banking as it exists today is inefficient, unjust and unfair.

The first transactions happened on a barter basis. That is, goods were exchanged for other goods. However, due to the inherent difficulties of this system, the concept of money evolved. Money is basically a common good or material that everyone would be willing to accept and exchange. For instance, if all traders consider wheat grains to be of use, and if wheat grains are scarce enough to ensure that only a reasonable amount of it would be required for an average transaction, wheat grains could become money. The unit could be, say, grams of wheat. Five grams of wheat, for instance, could buy a chocolate.

Wheat grains, however, were not used as money for too long. The first truly enduring money used by man was gold. Thus, gold became accepted as a currency which could be exchanged for goods. The currency units of different countries were, in fact, initially based on the weight of gold used in making one unit. The pound sterling, for instance, was just that – one pound of gold. Till date, there are tribes that refuse to accept anything but gold as money.

However, as time progressed, people started using paper receipts against given quantities of gold for trade transactions. Thus, instead of paying, say, 100g of gold, a person could now pay a receipt that could be redeemed for 100g of gold.

However, man is always inclined to tweak things in a way that would benefit him most. As more and more transactions started happening through exchange of paper receipts, lenders started giving out receipts in lieu of hard money, i.e., gold. This was perfectly fine, except that, for the same quantity of gold, lenders started giving out multiple receipts, to increase their earnings.

According to the author, what is happening today is analogous to the scheme described in the above paragraph. Banks today have to hold a certain amount of money as reserves, and can lend out N times this amount, where N is the money multiplier, given as the reciprocal of the Cash Reserve Ratio. Thus, if the combined reserves of all banks increase by $100,000, and the Reserve Ratio is 1/5, they can, cumulatively, loan out an additional $500,000 ($100,000*5). The excess of $400,000, in the words of the author, is ‘created out of thin air’. To make things worse, we also have central banks, which existing banks can always count on for a bailout if things go bad.

The book is written in a very engrossing way, and is structured perfectly. The transition from one chapter to another and one topic to the next is very natural. The book gets the reader thinking with its compelling presentation of facts and inferences, and its uninhibited attack on the banking system as we know it. For readers who like economics, this book gives a completely different perspective to the monetary system as it is widely defined, and is highly recommended.

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