# On what basis, is currency created?

This is more like a homework question. I am quite a beginner. I would appreciate any help, preferably with less technical terms, that guides me in the right direction.

I went through the Wikipedia articles on Money, Debt, Government debt, Internal debt. And somehow I understood these lines from these articles.

Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context.

Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor.

Governments create debt by issuing government bonds and bills. Government debt can be categorized as internal debt (owed to lenders within the country) and external debt (owed to foreign lenders).

Internal debt or domestic debt is the part of the total government debt in a country that is owed to lenders within the country.

Perhaps, I came across hints but could not understand

• How does any government "create" the currency in the first place?

• Do the central banks just print some notes and offer it as a service? Say, Use our notes as an exchange medium

• Or, is it something like we own the land and other assets, we put it at a value of some X amount

• Is it something else?

## 1 Answer

How does any government "create" the currency in the first place?

Do the central banks just print some notes and offer it as a service? Say, Use our notes as an exchange medium

Currency in economics is just the notes and coins in circulation. These are minted and printed by government. In every country the institutional arrangement will be bit different. In some places central banks do the printing/minting of the currency in some others its done by mints or treasury departments. In US the printing of paper money is done by The Bureau of Engraving and Printing (BEP) and minting is done by the US Mint (see explainer in Investopedia). These agencies are nominally under the treasury department but in practice they create new currency when Fed orders it.

If you are interested in money more general not just currency (i.e. notes and coins) then in general money is created by Fed with help of private banks. The money is created whenever bank makes a loan as whenever a loan is issued a matching deposit is created with the money in it. This is done for a most part all electronically. The amount of loans private banks can issue depends on monetary policy of Fed, its regulations and how much reserves/base money it creates (if you are interesting in reading more on this you can have look at this BoE paper McLeay, Radia, and Thomas; 2014). Money is also created when Fed directly purchases some assets, for example when Fed purchases treasuries it is done with newly created money.

It is not enough to just say: "Use our notes as an exchange medium" in fact there are many examples of countries where people decided simply not to use official government issued money but decided to switch to some other money (this is known as currency substitution). For example, in Zimbabwe people substituted their local currency for dollar (such currency substitution is called dollarization) and in fact between years 2009-2015 even government of Zimbabwe decided to give up and declare dollar official legal tender.

In order for money to be used there must be some demand for it. The demand for money can be created by government requiring that all taxes be payed with its issued currency. Furthermore, in order for people to keep using the issued money they must also be able to perform the function of money reasonably well (i.e. be medium of exchange, unit of account and store of value). In Zimbabwe the problem was that due to hyperinflation money completely lost its store of value function and hence people decided to use dollar - but that's just one example.

Or, is it something like we own the land and other assets, we put it at a value of some X amount

Not anymore. Modern fiat money are not backed by anything of intrinsic value. In the past under gold standard money was backed by gold and ever further in past money was literary some commodity (it could be gold or other precious metals, but also shells, stones, coca, cigarettes, livestock etc.). In such systems money derived their value also from the intrinsic value of the asset (or more precisely commodity).

If you want to know about history of money then a good non-technical account is provided by Ferguson in Ascent of Money and more technical account can be found in Davies (2010). History of money.

• The US also has a rule that its money is to be used for the settlements of all debts, and refusal to accept legal tender for an existing debt wipes the debt. – Simon Richter Oct 6 '20 at 15:04
• Curious about your opinions on how much money you think is endogenously created (by private banks) vs. exogenously created (by the Fed). Also additionally I just read a report saying the Fed no longer has reserve requirements, as of March 29th. federalreserve.gov/monetarypolicy/reservereq.htm – Davis Clute Oct 6 '20 at 15:37
• @DavisClute this can actually be answered factually without opinions. Monetary base was in 2020 about 5 trillion (which includes the notes and coins minted. The M2 was about 19,000 billion in 2020. So about $97,5\%$ are created by banking system. fred.stlouisfed.org/series/BOGMBASE fred.stlouisfed.org/series/M2 – 1muflon1 Oct 6 '20 at 15:53
• @1muflon1 Thanks for the excellent answer. It took me some time to understand it. Out of confusion, I had missed something when I asked this question. The question is, how much bills are created right in the beginning? Does the value of the "first currency printing" depend on any factors like GDP? And how are those valued anyway? Say, I have just inherited a kingdom. I have launched my own currency. Which factor would decide what does a single unit of that currency would provide? – user28021 Oct 7 '20 at 6:07
• @Madhurjya how much money is valued depends on price level which is determined by money market equilibrium which can be in its simplest form described by equation of exchange MV=PY how the equation works was actually already explored here a lot here are some answers: economics.stackexchange.com/a/37389/15517 economics.stackexchange.com/a/39142/15517, you can read Blanchard et al Macroeconomics: a European perspectives chapters on IS-LM with emphasis on LM to learn more – 1muflon1 Oct 7 '20 at 8:14