Dawn Ridler, an independent financial advisor in Johannesburg, has a wonderful way of demystifying the most complex financial topics. In this piece, she takes a look at the cash in our wallets and purses. She asks: Do you know what makes those pieces of paper have value, so that you can use them to pay for goods and services? Then, she takes a look at some complex mechanisms, like quantitative easing, and other aspects of the banking system to unravel some of the mysteries about money. If you’re contemplating a personal finance overhaul in 2017, understanding how money works is a good starting point. After all, the more you know about how money works, the more you can use it to your advantage. – Jackie Cameron
By Dawn Ridler*
Most of us don’t think twice about opening our wallet and handing over cash or plastic. Perhaps we think this is just a form of barter: you give me something and I will give you something back of equal value – and money is just one of those ‘things’ we can barter with.
I suspect we think that all that money is backed by investments in the bank in one shape or form. Not so.
In effect banks ‘create’ the money but it is ‘leveraged’ – in other words they don’t lend out R1 for every R1 they have in investment but much more than this. The degree to which they can leverage themselves (lend more than they hold) is controlled by their ‘capital requirements’ – an amount that has increased over recent years following the credit crisis fall-out.
You’ve probably heard of QE or quantitative easing. This a monetary policy governments use when ‘normal’ monetary policy (interest rates) fail. Basically, with QE governments buy bonds from financial institutions to increase their liquidity in the hope they will lend out the money and get the ‘Money-Go-Round’ going again. In other words pushing it out of its inertia and giving it some momentum so it can go around by itself.
Unfortunately this has had limited success, mostly because the banks aren’t getting enough of a ‘margin’ (aka profit) because of historically low interest rates. Banks have also been inefficient and are now having to use technology to become more competitive – and have been haemorrhaging jobs as a result.
Let’s illustrate this “Money-Go-Round” with a short tale:
In a small dorp in Limpopo, a German tourist walks into the local B&B and puts R500 on the desk. “I want to look at your room upstairs and maybe I will stay here, Ja?”
“Sure,” answered the owner, Jacob, handing the tourist the key to the room.
The tourist heads upstairs and Jacob looks at the money on the desk. “What if he doesn’t stay?” he thought to himself – fleetingly – before picking up the money and heading to the liquor store next door and settling his long overdue account so his supply would start to flow again.
The Liquor store owner looked at Jacob and the money in surprise, but smiled his thanks and placed it in his pocket. Once Jacob was out of the door the liquor store owner walked across the street to pay the hairdresser’s account that his wife had clocked up on her last visit. She, in turn, closed up the shop, flicked the ‘back in 5’ sign and went to the petrol station and paid her account there.
Jan, the garage owner, put the money straight in his back pocket and found the local call-girl at her favourite seat at the bar nursing her first drink of the day and slipped her the money quietly. Finishing her drink in one gulp she hot-footed it over to the B&B to pay off her room account with Jacob, with the bar owner in hot pursuit wanting his share of her money.
She found Jacob standing at the reception desk somewhat nervously watching the stairs. The call-girl put the R500 on the desk and he burst into a huge smile. The bar-keep burst through the door, but she shrugged her shoulders in an age-old gesture of “Sorry for you!” As she turned to go, the German tourist came back downstairs shaking his head. He handed back the key to Jacob, picked up the R500 off the desk and left.
What just happened? Nobody made any money but all the debt in the village has now been settled and everyone is happy and spending again.
This is how money works, and why, if anywhere in the pipeline the money stops flowing, then the whole system comes to a stop. The Tourist is the equivalent of the bank. If Jacob had left the money where it was, nothing would have happened and there would still be half of the village in debt to each other.
* Dawn Ridler is an Independent Financial Advisor with extensive experience in both financial advisory and business. Her unusual combination of an MBA, BSc and CFP ® has evolved into an ‘ecological’ and holistic approach to advisory, which she has tagged ‘Wealth Ecology’ in her company, Kerenga.
This article is published here on BizNews.com with the kind permission of Dawn Ridler. Copyright: Dawn Ridler
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