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MGT411 - Money & Banking
Graded Discussion Board
Title: Form of Money
The objective of this question is to enable the students in understanding the various forms of money and its importance in overall economy of a country.
Suppose there is hyperinflation in a country and the prices of goods in that country are increasing day by day. Keeping in view of this situation, the prime minister of that country called a meeting of its cabinet in order to tackle this situation. In this meeting, some of the cabinet members were of the view that the government should withdraw all the old currency in circulation and issue new currency notes backed by the gold reserves. However some of the members of the cabinet disagreed with this suggestion and supported the current fiat currency system.
Keeping in view of the above scenario, you are required to give your opinion of this issue. Whether the gold based or fiat currency system is better for economic growth and smooth financial system of a country? Provide strong logical arguments in support of your opinion.
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Hyperinflation is extremely rapid or out of control inflation. There is no precise numerical definition to hyperinflation. Hyperinflation is a situation where the price increases are so out of control that the concept of inflation is meaningless.
When associated with depressions, hyperinflation often occurs when there is a large increase in the money supply not supported by gross domestic product (GDP) growth, resulting in an imbalance in the supply and demand for the money. Left unchecked this causes prices to increase, as the currency loses its value.
When associated with wars, hyperinflation often occurs when there is a loss of confidence in a currency's ability to maintain its value in the aftermath. Because of this, sellers demand a risk premium to accept the currency, and they do this by raising their prices.
Fiat money is currency that a government has declared to be legal tender, but is not backed by a physical commodity. The value of fiat money is derived from the relationship between supply and demand rather than the value of the material that the money is made of. Historically, most currencies were based on physical commodities such as gold or silver, but fiat money is based solely on faith. Fiat is the Latin word for "it shall be".
? The first means of payment were things with intrinsic value like silk or salt.
? Successful commodity monies had the following characteristics
? They were usable in some form by most people;
? They could be made into standardized quantities;
? They were durable;
? They had high value relative to their weight and size so that they were easily transportable; and
? They were divisible into small units so that they were easy to trade
? For most of human history, gold has been the most common commodity money
? Today we use paper money that is fiat money, meaning that its value comes from government
decree (or fiat).
? A note costs about 0.04% its worth to produce.
? These notes are accepted as payment for goods or in settlement of debts for two reasons:
? We take them because we believe we can use them in the future.
The law says we must accept them; that is what the words “legal tender” printed on the note
? As long as the government stands behind its paper money, and doesn’t issue too much of it, we will
use it. In the end, money is about trust.
Advantages of Fiat Money
? Fewer resources are used to produce money.
? The quantity of money in circulation can be determined by rational human judgment rather than by
discovering further mineral deposits—like gold or diamonds
? A corrupt or pressured government might issue excessive amounts of money, thereby unleashing