Amar, we're here in the Bank of England's gold vaults to talk about money, and for some
periods historically, money could be converted at the Bank into gold.
Now, your article is about money in the modern economy.
Could you start by saying a few words on why it is that we have and use money in our everyday
lives?
People have and use money because they want various things.
Money allows us to acquire the goods and services that we want when we want them.
Without money, this would be difficult.
People would typically only be able to consume what they produce.
So let's take a very simple example of a farmer who would only be able to consume the produce
that he grows on his land.
Without money, he would only be able to consume other goods, such as fish, if he were able
to find a fisherman willing to exchange some fish for some of his produce, say, some berries.
In practice, people produce and want to consume different things at different times.
So the fisherman may not have any catch until autumn but might want berries during the summer
when they are in season.
One solution to this problem is for the fisherman to give the farmer an IOU in exchange for
some berries and when autumn comes, the fisherman would then be able to fulfill his IOU by giving
the farmer some fish.
I see.
So the IOU then, which is simply a promise to repay someone something at a later point
in time for something they've received today, emerges as a means of exchanging goods or
services.
But what then is the link between the IOU in that example and money?
Well, money is just a special form of IOU.
You can imagine where there's lots of people interacting, trading lots of different goods
and services.
If everyone was just issuing their own IOUs, things would get very complicated very quickly.
And crucially, for that system to work, everybody would have to trust one another.
So even though I may trust you, if you give me an IOU and your ability to fulfil the IOU
depends on an IOU that you have from somebody else, I would then have to trust that person
in order for me to think that your IOU was worth anything.
So if we consider money today, in what sense is a £20 note, say, an IOU?
In the case of banknotes, the Bank of England, the central bank, is a monopoly supplier of
banknotes in England and Wales.
In addition, some commercial banks in Scotland and Northern Ireland are also authorized to
issue banknotes.
So the £20 note that you're talking about is an IOU from the central bank to you.
That's where the famous "promise to pay" inscription comes from.
What exactly does that mean, though?
Does that mean that the Bank of England could give me £20's worth of gold in exchange for
a £20 note?
Not anymore, no.
While that was true in the past, the monetary system today is very different.
While it is still true that the £20 note represents an IOU from the Bank to the holder
of that note, banknotes today are what's known as "fiat", or paper money.
A £20 note is worth £20 precisely because everybody believes that it will be accepted
as a means of payment both today and in the future.
And for everyone to believe that, it is important that the money maintains its value over time
and is difficult to counterfeit.
It's the central bank's job to ensure that that is the case.
Now, you mentioned money held in bank accounts as the other main type of money.
That's right.
In fact, banknotes and coins make up just 3 percent of the money held by individuals
and companies in the British economy today.
The remainder, and that's the vast majority, is held in people's bank accounts.
So how is the money in my current account different from the cash in my wallet, for
example?
As we discussed, money is an IOU.
So the cash in your wallet is an IOU from the Bank of England to you, and the money
in your bank account is an IOU from your bank to you.
For example, if you have £200 in your current account, that means that your bank owes you
£200, and that money functions just the same way that the currency in your wallet does.
In fact, today, most people get paid directly into their bank accounts and frequently use
that money to pay for goods and services, for example, when you use your debit card
at the supermarket.
For bank deposits to be trusted as money, they have to be convertible with currency.
So just as you can pay money into your account at your local branch, you can withdraw cash
from an ATM machine.
So making sure that customers can exchange money in their current accounts for currency
is one of the key services then that banks provide.
Exactly, and it's worth noting here that even in the unlikely event of a bank failure, households
deposits up to £85,000 are protected by the Financial Services Compensation Scheme.