Wednesday, 26 September 2012

Jens Weidmann on Money and Money Creation

Dr Jens Weidmann, President of the Deutsche Bundesbank and Member of the Governing Council of the ECB, and a strong opposer of Draghi's plan to buy sovereign bonds, gave a speech recently in Frankfurt. Here's what he said about Money and Money Creation,
I wish to begin with a question which appears trivial at first glance but which, as experience has shown, is particularly difficult. What is money exactly? A succinct response from an economist would be: Money is what money does.
As money is defined by its functions, various instruments are fundamentally capable of acting as money, as long as they can be used as a medium of exchange, medium of payment and store of value.
Shells were previously used as money in some countries, for example, as were furs, salt or pearls.Livestock could also serve as money – the Latin word for cattle is “pecus” from which the word “pecunia”, meaning money, is derived.
Concrete objects have served as money for most of human history; we may therefore speak of commodity money.A great deal of trust was placed in particular in precious and rare metals – gold first and foremost – due to their assumed intrinsic value.
In its function as a medium of exchange, medium of payment and store of value, gold is thus, in a sense, a timeless classic.“To gold they tend, on gold depend, all things!”, says Margaret in the First Part of Goethe’s Faust.
However, the money that we carry around in the form of banknotes and coins no longer has anything to do with commodity money.Money has no longer been linked to gold reserves since the US dollar was removed from the gold standard in 1971.
In short: today’s money is no longer backed by any real assets.Banknotes are printed paper – and the experts amongst you know that the euro is printed on paper made of cotton – coins are minted metal.
That banknotes and coins are accepted as a medium of payment in our daily lives also has to do with the fact that they are the only legal tender.However, ultimately the acceptance of banknotes is based on public confidence that it can use this paper money to make purchases.
In this sense, money is a social convention – it has no intrinsic value which comes before its use; instead, its value is created by its constant exchange and use as money. By the way, this recognition that trust is central, or even constitutive, for the properties of money is very old;it was already discussed in the 4th century BC by Aristotle in his Politics and Nicomachean Ethics.
In recent times, in particular, many citizens are asking about the origin of money: where do the central banks actually acquire the huge amounts of money that they need to give billions in loans to the banking system as part of monetary policy operations or to make other purchases?Why it is often repeated in this context that central banks have virtually unlimited firepower? 
The printing of money is an appropriate image here; from an economic perspective, the printing press is not necessary, as the creation of money primarily shows up on the central bank’s balance sheet, on its accounts.
 Read his whole speech here.

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