The Issue Of Money Supply

Posted by Allison on 6 April 2009, 15:06

Most of us have at least a rough idea of how much money we have in our bank accounts, and probably in our pockets as well.  We know how much cash we have saved up.  But how much money is there in our entire country – and more to the point, who decides how much is enough, or how much is too much?

Welcome to the world of money supply, the term given to how much money a specific country has at any one time.  Just as you can arrive at a figure to determine how much money you have personally, so the government knows exactly how much money is in circulation in the country as a whole.  This applies to every country in the world.

But why is the money supply so important?  Why does it matter how much of it there is in circulation?  Obviously there would be problems if there wasn't enough, since we would all be short of it, but is it really possible for there to be too much?

In short, the answer is yes.  While we would all love to have more money, if there is a general and substantial increase in the amount that is around, then it can affect the economy as a whole.  If people have more money in general they tend to spend more, and if this happens over an entire country then the results can be profound.

Take the experiences that we have had in recent months in the UK for example.  For months we went through a phase where everyone had a lot of confidence in the economy – interest rates were low and people felt confident in spending more money.  But that often leads to prices starting to rise, and when that happens people start to struggle since their money won't go as far as it used to.

Basically if the money supply grows then there is a real risk that inflation will go up as well.  Inflation means that prices go up, so the money you have in your pocket won't stretch as far.  And one step beyond inflation (albeit quite a large one) is hyperinflation, which means that the currency really starts to spiral out of control, and what used to cost sixty pence might end up costing sixty pounds, for example.

But different countries tend to have different opinions on how important the money supply problem is.  Some governments keep a very close eye on their money supply and are constantly keeping it under a tight rein in the hope of keeping inflation under control as well.  Other governments aren't as worried and seem to be far more casual in their treatment of it.

If you take a look at the graphs which reflect the money supply which has been available in different countries over the years, you will see that in every case the trend is towards an increasing money supply.  Over time inflation does have an effect on the way we live – it's an undeniable fact that the vast majority of prices continue to rise over time, and this means that things get more expensive to buy.  Conversely however we tend to earn more as our wages and salaries rise (in theory) enough to combat the effects of inflation.  So in simple terms if you earn £100 a week and your outgoings rise by 5% because of inflation, then your wages should rise by 5% as well.  It doesn't always happen that way though, as many people know.

But no article on the subject of money supply would be complete without making mention of the issue of virtual money.  Before the internet came along we had our coins and our banknotes and everyone knew where they stood.  Now we have electronic banking; wads of virtual cash can change hands at the click of a button or the press of a mouse, and the control the governments have over money supply is starting to slip.

While the development of virtual money exchanges taking place online has undoubtedly been a great advantage for us, it may prove to be the beginning of a huge change as far as the governments are concerned.  We are relying less and less on actual physical money as time goes by; coins and banknotes are being used less, and we rely on our credit cards, debit cards and indeed those virtual online transactions to pay bills and pay for goods that we buy. 

You might wonder how this can affect the money supply – after all if something costs £10 it will cost £10 regardless of how we pay for it.  But a £10 note is a part of the money supply and as such is a tangible object.  If you apply for a credit card you are given a credit limit that has nothing to do with the money supply; it is decided upon by the credit card company who gave it to you.

So let's say everyone in the country applies for a credit card and they are all given a £5000 credit limit.  If everyone decides to spend their £5000 that is a huge amount of personal debt that they then need to find the money – the actual cash – to pay for.  And that comes from their part of the money supply.

That's why the money supply is so important.  The amount – or lack – of it can have a real bearing on the economy and the confidence of the country as a whole.  It will be interesting to see how banks and governments cope as the march of the internet leads to more virtual money and less control for them.  Will we still have notes and coins in, say, fifty years from now?  If we don't where will the government stand?  Will there still be such a thing as banks?

There have been major upheavals in the world of currency before, such as when banknotes first came into being.  Perhaps there is another major upheaval about to happen?

 

Comment

  1. This was a really enlightening article. I particularly enjoyed the bit about the credit card with the £5000 limit and what would happen if everyone had one and spent all the cash at the same time. There is definitely a difference between actual money and virtual money, and this is something more people would do well to understand. Imagine being able to spend money like that and get the country into a lot of trouble in the process!

    — CShort · Jan 31, 01:17 PM · #