If there is not enough money in the british banks why can't we print more money?

This is the answer that I posted to a similar question earlier this week. Although the question was a bit different, the answer will help anyone curious about this subject:

A currencies value is based on the same thing that determines the values of all things, supply and demand. Letâ€™s start on the demand side. This usually confuses people because they can never imagine money having a lack of demand. However, in order to hold a currency you have to trade something else for it. Most people trade their labor for currency, then they trade their currency for shoes, food, insurance, cars and so on. In this case the demand is for consumer goods and not currency since they are willing to trade their currency off for it. If on the other hand you would save this money, the demand would be for the currency and not the consumer goods. The more money that is saved, the more scarce it becomes, thus, pushing up its value. The faster money changes hands â€œthe velocity of moneyâ€ makes it seem that money is easily available and therefore loses its value.

There are 6 places where one could store ones wealth: stocks, bonds, real estate, commodities, currencies and consumer goods. If there is more wealth going into an asset class than leaving it, its value rises, if more wealth is transferred out of an asset class than is entering, it losses value. If currency is only a means for exchanging one asset class for another and the wealth is not stored in that currency, then the velocity of that currency is high.

But why is one currency stronger than another? Think of different currencies as if they represented different communities, in order to want to hold assets (currency) in that community, you would need to feel that the community is well governed (good fiscal and monetary policy), the people that live there take care of their properties and that these conditions should continue (stability), or you will most likely look for another community (currency) to invest your wealth in.

Now for the supply side, there are two main types of currencies, commodity and fiat. A commodity currency is backed by an underlying commodity such as gold, silver, oil or anything else a government chooses to peg a currency to. This means you may redeem the currency for a set amount of the commodity that it is backed by. The U.S. dollar was a commodity currency until the early 70â€™s when Nixon removed its peg to gold. This was done because we printed more dollars than we had gold to back it. Foreign governments knew this, therefore, started trying to redeem their US$â€™s for gold instead, forcing us to default. A fiat currency is only backed by its government. The issuing government orders that it must be accepted as means of payment. There is no underlying asset that itâ€™s pegged to, therefore, no set amount of anything that it may be redeemed for. For this reason commodity currencies have been historically more stable than fiat. All major currencies are now fiat.

With no set amount of redeeming value, a government may print as much of their currency as they choose. This will only benefit the initial user since it dilutes the value of the existing currency, more supply without an increase in demand. Therefore, when the government prints off excess currency it can be seen as a redistribution of wealth, since each dollar printed steals its value from all the other dollars that exist. This devalues the savings of all the people who chose to hold the currency instead of trading it, devaluing their past labor, goods and services. This is why the rich prefer to trade their currency for hard assets.

Just as government spending has a large affect on the money supply so does the fractional banking system. Banks can lend out the same money up to five times! This happens because the bank only has to hold 20% of any deposit in reserves for demand. This means 80% of your money can be lent out to someone else. When this person deposits their loan, the money is now showing up not only in your account, but theirs as well. The person who received this loan via deposits now has a deposit as well, which the bank can lend against. This process can be repeated over and over causing the same dollar to show up in as many as 5 accounts. I know this may sound hard to believe, therefore, you should not take my word for it, but rather look it up for yourself and youâ€™ll be surprised to see how our banking system really works. Anyway, the more banks lend the more money supply that comes into existence. This money is created out of thin air, and when repaid, disappears just the same. This is why credit expansions cause inflation and credit crunches cause deflation. This is also why interest rates affect the money supply. Low interest rates encourage borrowing and high rates have the opposite affect.

Of course there are more dynamics to the valuation of a currency than I can go into here, therefore, many stones are still left to be turned for a complete view. However, I think what I have written above is a pretty good start and I hope that it was helpful to you and anyone else interested in this subject. If you or anyone have any further questions, feel free to message me.

Kong