Quote:
Originally Posted by FanaticOnWheels Now, this basically means that this country, has in it's ownership, the gold reserves of some other country, right? |
Even this is not an easy concept. Gold was used when it was the only commodity that could play the universal currency. But now you can use lot many things.
Even a country with no gold can print money. Let me explain how, do note this is a simplistic example.
Consider a country X, started by 100 people, there is no currency or economy of any sort. Among the 100 people, they have various skills and they start making use of those skills.
Some are hunters, so they go hunting and bring the food.
Some are builders, who build shelters for people to live.
Some are tool makers (carpenters & blacksmiths), who make tools and weapons needed by others.
Some are foragers, who collect various items from the forest, which can be used as food or make to cook food.
Some are artisans who make leather clothing and other items of decoration.
Some are cooks, who can cook all kind of delicacies.
Some are people with varied special skills like healers, entertainers, managers, etc.
If you look at the above list, you will note that everybody needs everybody else, but not to the same extent. In the absence of any currency, they have to do lot of bartering. That's what they did in the early days. Rare items had more value, common items has less value.
Eventually bartering was replaced with currency. Anything that is used as currency couldn't be reproduced easily, then it would lose value. If they used stones, then anyone can get a stone from their surroundings. So they used precious metals like gold and silver which were limited in nature.
But what if you had no gold or silver? One brilliant man among the above bunch comes up with an idea. He goes to an artisan who has a very unique skill, an ability to create a very special kind of flax clothing, no one else knows how. He is asked to make 1000 pieces of one square inch cloth, which are numbered. Each of the 100 citizens are given 10 pieces and are asked to use it as currency. Soon they are using the special cloth as currency, different products and services soon end up having price set in cloth pieces by free market demand and supply conditions. Now if the artisan makes and releases more cloth pieces into the tiny economy, then the value of currency will go down. On the other hand if 10% of the cloth pieces are taken away from the economy, value of currency will go higher. No gold needed here.
Now let's go international. Consider country Y, which is a similar economy. They are low on food, but they can make very good machinery. They want to trade with country X, which is rich on food, but low on machinery. Country Y uses specially carved wood pieces as currency, very hard to duplicate. Now citizen Y1 approaches citizen X1 who is a hunter.
Y1: Hello Mr.X1, I want to buy food from you.
X1: You are welcome Mr.Y1, but you don't have my cloth currency and I don't need machinery.
Y1: Oh, that means I need some cloth currency first.
So Y1 will approach another citizen of X who is a tool maker.
Y1: Hello Mr.X2, you could make use of my machinery.
X2: Yes Mr.Y1, your machinery is useful to me, but I have no wood currency required to buy your machinery.
Y1: Tell you what, I will sell my machinery to you for cloth currency.
X2: That's great, let's negotiate a price.
Now Y1 comes back to X1 the hunter.
Y1: Hello Mr.X1, now I have some cloth currency with which I can buy food.
X1: Wow, that is nice. Now let's negotiate a price.
As you see, gold is again irrelevant. This became possible only in the last couple centuries as most countries started having central banks who could be trusted to print currency responsibly and underwrite it's value. Printing more will only de-value the currency, so there is no real gain in that.
If X makes too much food and starts exporting a lot, then they end up holding currencies lot many countries. Those currencies can be used to buy products and services from other countries. That is how world economy works to put it very crudely.