Money and the Myth of Saving

Author intends to discuss the concept of money and why we should not consider saving money. In a high level the entire article is based on the introduction of fiat money, inflation and increase in money supply.

Money was a norm way before we were born and we had no choice to question the behavior of it. Former generations have already accepted it, therefore its even hard to question and we have inherited the belief. We live in a world where success is measured by wealth. Money is considered the key variable.

Understanding the monetary system or about money will do no harm but you have to have the ability to question the norms of the society. Cultures and governments built upon values and agreements. Same applies to money and also money is connected to every bit of everything.

“It is well that the people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.” — Henry Ford, Founder, Ford Motor Co.

ready ? set go…

Lets say a currency bill is printed with 10, then it values 10 rupees of goods. Then another bill which is slightly bigger in size is printed 100. This bill can get you goods up to 100 Rps. End of the day its a piece of paper, but the vendor will provide you with goods that’s worth 100 Rps. For a second think why did he do that?

Lets say a bottle of milk was priced at 10 rupees two days ago. But today its priced at 11 rupees. Your 10 rupee bill cant get the same milk bottle today. Which means your 10 rupees has been devalued and its buying power has been reduced. (This is actually called inflation and you will hear more about this during the article)

Lets understand the concept of money a in depth.

Printed money has no real value unless we believe in it. This is basically the Tinkerbell effect. It says that something has a value because we believe in it. We use fiat money now. Which does not have a actual gold backing to the printed currency.

Money has seen many stages, in the late 1100’s commodity money was used by the traders. Then came representative money which the central banks had to have a gold deposit to print money signifying it was backed by a like amount of gold. Due to the world wars and various major business expansion needs the world needed more money. Initially the gold standard was reduced but later it was fully taken off in 1971 by the US. This is the beginning of fiat currency.

By 1971, the United States was essentially bankrupt; it did not have enough gold in the Treasury to redeem all the dollars in circulation.That year, President Nixon severed the link between the U.S. dollar and gold. With his act, in effect, every currency in the world — thanks to the dollar’s status as the world’s reserve currency — became fiat currency.

Fiat is just a fancy word that means a currency is officially printed and accepted by a government. It’s like a symbol of authenticity. Fiat currencies only have value because the governments who print them say they do. They are official sheets of paper. Technically, they’re worthless. Fiat currencies can’t be redeemed for gold or silver. And because of that, all fiat currencies lose value ..

Central Banks has the full authority to control the printing flow and no deposits like gold are needed. If money is grown on trees then its values is the same as the tree leaf. Therefore the value lies upon the amount of money being printed.

Central banks are gifted the power of printing money to a nation. The Central Bank of Sri Lanka (CBSL) has the sole authority to issue currency notes and coins on behalf of the Government of Sri Lanka. At the end of the first quarter of 2019, currency notes and coins in circulation amounted to Rs. 688 billion.

If a nation’s economy were a human body, then its heart would be the central bank. And just as the heart works to pump life-giving blood throughout the body, the central bank pumps money into the economy to keep it healthy and growing. Sometimes economies need less money, and sometimes they need more.

The quantity of money circulating in an economy affects both micro and macroeconomic trends. At the micro level, a large supply of free and easy money means more personal spending. Individuals also have an easier time getting loans such as personal loans, car loans, or home mortgages. At the macroeconomic level, the amount of money circulating in an economy affects things like gross domestic product, overall growth, interest rates, and unemployment rates.

Why not print more money ?

Printing more, the money itself becomes less valuable. Since this can cause major inflation, simply printing more money isn’t the first choice of central banks.

Money transfer methods and payment methods have evaluated over time. In Sri Lanka, Cash is still the main player. Bank drafts, cheques and various digital payment methods have been introduced. Moving on to a digital age, banks use software to manage transactions and maintain the ledger balances. A typical number column in a database will be used to record the balance of a customers savings account. When a credit transaction is done, the balance will increase and when a debit transaction is done the balance will decrease from an entity. Here we don’t see printed money bills moving across. Its just digital records in a table, yet we consider those as a real values. This is virtual money being transferred around. If you consider Sri Lanka, the figure 688 Billion will cover money in all forms.

Since I deviated from the topic a bit, lets get back ..

Well of course the 688 Billion is not a static value. As you are aware by now the CBSL have the authority to print money and this figure has been changed yearly from its inception. I have given below a chart from CBSL, which shows clearly a rapid increase in money circulation within the country.

chart 1 : Money Circulation over the years

“Money Supply in Sri Lanka has increased to 627073 LKR Million in July from 621555 LKR Million in June of 2019. Money Supply in Sri Lanka averaged 98506.86 LKR Million from 1960 until 2019, reaching an all time high of 687638 LKR Million in March of 2019 and a record low of 602 LKR Million in January of 1960.” says CBSL.

For a second, by looking at the chart above, think about the value of 10 rupees in 1960 and now. If you ask your parents, they will tell you the worth of 10 rupees back then and the goods you can purchase for that amount. But what can you do with a 10 rupee note now? Inflation and the increase in money supply into the system has devalued the currency.

Lets understand inflation in depth. As per the central bank the current inflation rates in Sri Lanka is around 4.5%. Which means the buying power of a rupee goes down by 4.5% every year. (I am not aware of the factors which are taken to calculate the inflation rate. But its not a lie that central banks keeps on removing the items/products that has a major impact in the rate. If you do a google search you can find many samples from other countries as well)

Given below is a chart from CBSL showing the inflation rates over the years and the predicted rate till 2024. Based on this if you do a basic math, your 1000 rupees today will lose its value by 45 rupees every year(rate is 4.5). But for sure the actual rate is well above the CBSL given rate.

take a second and think, same kind of impact will not happen to your cash savings ? Or in other words to your fiat money savings ..

chart 2 : Inflation rate over the years

Upto now I have tried to convinced you that the value of money keeps on changing along with its buying power.

Why do people save money still ?

To start, I have mentioned the value of a 10 rupee in 1960 and the things you would have been able to do with it. On the same note, think you saved 10 rupee per month in 1960 and what would the value be by now? With 10% interest you have a figure of 7920.00 rps after 60 years.

{(10*12 + (10*12)/100*10 ) * 60}

We as Asians were brought up in a way that we were told saving money is the way forward. Ancient kings of Sri Lanka used to save their wealth (we call these treasures), and it was the same in countries like Japan, India. For generations this was the same and its in our blood to save wealth for future use. But all these were physical wealth, gold, diamonds which was real. This theory does not apply to fiat money.

When you say Cash is not king! Cash is trash ! it sounds alien to us.. but well known author of the “Rich Dad Poor Dad” Robert Kiyosaki is a strong believer on this.

Mr Kiyosaki goes on to say, after taking off the gold standard money became currency in 1971(in US). Which means there is no real value to money. More the money in the system, the demand for the product goes up. The price of a oil barrel in US was 10$ about 20 years ago. Now its like 54$. but in 2008 it was hitting 130$. I am just wondering if the barrel just got bigger ? No cant be. US dollar itself has lost its value almost 80% after 1971. Even if the banks keeps you paying 6% or 10% interest rates you for the savings, you cant keep up with central banks money printing and inflation. Its fair to say that saving money is the old rule.

If some one has a lot of savings today, does that make him rich? Yes Temporally

Lets see how the world behaves for a moment, we have rich countries and poor countries. Then we have counties in dept. Do we call a country in dept a poor country ? United States of America has a national debt of $19.23 trillion (USD), Japan has a dept of 9 trillion USD. Most of US’s dept is owned by China as I have read. Basically what I understand is these countries borrow money and invest in development projects and you basically dont use your savings for these. In-fact US has the lowest percentage of savings. So we have to understand that being in dept is good. But also it has to be good dept.

Robert Kiyosaki, often says people like us are programmed to go to school, take a job, save money, buy a car, invest in the stock market. Rather than going to school, if we had studied money we should be knowing the system better. Unfortunately even an MBA will not teach you money and about the real system. Getting out of dept or fear of being in dept is stupid, coz money is itself dept.

Most of us work and earn a pay cheque end of the month. Then we also pay our taxes out of it. We plan to save a bit of it. But we are not questioning our self’s the point of saving when money itself is a printed entity. Commercial banks wants you to save money, promotes saving and offer good interest rates. Issue here is the banks target the middle class and wants the middle class to save. Sri Lankan banks offer comparatively good interest rates. But most countries dont tempt to promote savings. US has a very low interest rate for savings. Japan has a zero interest rate. All this is done to promote entrepreneurship. I believe the Japs and the Americans are thought not save and saving is a myth.

Banks earn money through lending out to the rich(with the capacity to repay). Banks will treat you with respect when you save with them, but will treat you like a king when you borrow. A banker really wants to know how much you can borrow. Not how much you can save. Why ? beacuse banks earn through fees and taxes. We need to understand that the entire system is constructed upon borrowed money, or in other words generated money.

Then again if banks earn money by lending out then why they ask customers to save?

Central Banks control the quantity of money in circulation by setting reserve requirements. As a rule, central banks mandate depository institutions to keep a certain amount of funds in reserve against the amount of net transaction accounts. A certain amount is kept in reserve, and this does not enter circulation. Say the central bank has set the reserve requirement at 20%. If a commercial bank has total deposits of 100 million, it must then set aside 20 million to satisfy the reserve requirement. It can put the remaining 80 million into circulation.

Simply the banks has to have a 20% as a liquidity(current cap by CBSL is a bit lower, you can check the current value in CBSL site). If you deposit 100, the bank can lend out 80% of it which is 80. This is called fractional reserving system. Someone else borrows that 80 and saves in another bank,that bank can lend another 80% of the total. Which is 80% from 80. This goes on. End of they day the system is been injected with new money. In this example there will be 80*5 = 400, new money injected into the system. So the money you save, generates more opportunity for banks to lend.

Watch this video during your spare time to fully understand how new money is created by banks : https://www.youtube.com/watch?v=JG5c8nhR3LE

How Banks Create Money

Working with credit money(borrowed) and being in dept is bad?

NO. I gave the example with countries before whom are in dept and by now we know that money itself is dept. Although I am not giving any of you financial advice here, buying good asserts through credit money is the way forward. But spending borrowed money on liabilities will make you poor and poor. (liabilities like cars, phones etc)

Mr Kiyosaki has famously said, The key is to use borrowed money (debt) to buy assets that creates net cash-flow for you each month. Then the debt turns into good debt and not bad debt, because it is debt that is letting you have an asset, that creates positive net cash-flow. Bad debt is used on liabilities that does NOT create positive net cash-flow for you.

conclusion : We need to learn to think money as a product and we can buy it from banks at a reasonable rate. Fiat money was created since the world did not have enough currency to expand the business when currency was entitled to the gold standard. As I see,people who save fiat money in FDs and stock markets are temporally rich, but they will loose it in a flash. All in all we can think that, fiat money was created for the purpose of improving the cash flow. Certainly it was not created for the savers.

Note : the content is purely created on personal interest and curiosity and has no other motive. Also the author deliberately avoided the discussion on the theory of taxes since it will be a different topic altogether. Certain points may be incorrect and I stand to be corrected. Please leave a comment :)

References :

https://goldsilver.com/blog/how-the-monetary-system-really-works-and-what-it-means-for-your-money/

https://www.youtube.com/watch?v=CQWwGLDNz34

https://www.youtube.com/watch?v=dN5qHjnd_xk

https://tradingeconomics.com/sri-lanka/money-supply-m0

http://www.sundaytimes.lk/190623/business-times/sri-lankas-financial-crime-rate-increases-with-black-money-circulation-354294.html

https://www.ceicdata.com/en/sri-lanka/monetary-aggregates/currency-in-circulation-held-by-central-bank

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