Impact of Financial Systems in The Development of Modern Economy

Introduction

We as a race have come a long way from exchanging commodities that had some intrinsic value as intermediary to now an imaginative, intersubjective creation for facilitating the exchange process in the present era. The system being used today has made the exchange process easy but now a question arises, how did we reach the current financial system that runs the economy?

Major factors responsible for the development

Globalization – An Integrating Force

“Money is one such imaginative creation that no matter what cast, creed, religion, or country a person belongs believes in”. The main cause of the same is its presence in the consciousness of many and its association with emotions like pleasure and happiness.

However, the question is, how does the financial system play a role in globalization?

Hunter-gatherers had no money simply because they did not need it. Each tribal band lived in a small area of its own and was self-sufficient. They hunted together and took care of each other, so therefore the economy worked through a system of favours and obligations. But slowly as they realized that resources are not equally distributed, hence needed to change places and meet with the members of other tribes to fulfil their ever-growing needs.

This posed the problem of mutual trust; how could one trust a stranger to return the favour for the work one has done for him/her? To solve this problem the ‘barter system’ or the commodity-to-commodity exchange evolved and came into existence.

Even though this system solved the short-term issues of an intermediary in a small economy but was not sustainable for a larger one because as an intermediary it required a double coincidence of want, wasn’t suitable enough to give out credit, there was a lack or difficulty in storage and transfer of value among many other problems which were needed to be solved.

These flaws opened room for a new system that needed to complement the trend of globalization the world was heading. The one that evolved ran on a currency with some value but finally culminated in a system that ran on a currency devoid of any intrinsic value. The formation of such a system made international trade easy and is one of the reasons we live in this interconnected system.

Money is the only system created by humans that can bridge any cultural gap, and that doesn’t discriminate based on religion, gender, race, age, or sexual orientation. Thanks to money, even people who don’t know each other and don’t trust each other can nevertheless cooperate effectively.

Credit – A Pioneer of Growth

Money has played an essential role in the development of the modern world because neither the modern government nor anything else can be sustained without it.

The growing financial system has been a reason for stupendous growth. In 1500, the global production of goods and services was equal to about $250 billion; today it hovers around $90 trillion isn’t that strange, that from the very inception of humanity till 1500 only goods worth $250 billion were produced in a year but now just within a span of five centuries the production has grown 360 times!

While this increment is a product of various factors, one major contributor to it is the development of the modern credit system. This system has given businessmen and entrepreneurs the power to represent imaginary goods – goods that don’t exist in the present with a special kind of money called credit. Before in most cases, money could represent and be used for the thing which existed in the present.

This imposed severe limitations on growth since it made financing new ideas and future enterprises difficult. Take for example a person who wanted to open a utensil store in medieval, to get the tools, he needs money, to earn money he needed to sell utensils. Therefore, the only way he could run his business could be if he gets hold of a dealer who is willing to sell him the material he wants for free in the promise of future repayment. But credit solved this problem. Thereby giving a boost to the development of businesses and ideas.

Credit can be called the difference between today’s state and that of tomorrow, but how? Because if you don’t believe that what’s ahead of you would be better than the current, why take the unnecessary risk…

Trust – The Framework of The Modern Economy

“Money is the most universal and most efficient system of mutual trust ever devised”

What gives a dollar bill its value? After all, it doesn’t have a value of its own, rather it is just a piece of paper. So, what has made it so valuable?

It’s the government’s backing and the trust of the people that the bill has some value irrespective of its intrinsic value.

The crucial role of trust explains why our financial systems are so tightly knit with the ideological and political systems, why financial crises are started by political issues, and why the stock rises or falls depending on the way traders feel in the morning.

For most of history, the currency circulated has had some intrinsic value by itself. However ever since President Nixon removed the gold standard in 1971, all we believe in is a government-backed piece of paper for the exchange process.

So how has the change affected the working of the system?

This system has given the government immense power relating to the supply of the currency, which wasn’t possible to that extent under the gold standard in which the currency had to have a backing of gold under a fixed rate. This lack of flexibility was a major flaw of the gold standard, which encouraged a trust-based system.

While this system has worked fine for a long time, now it is facing headwinds. People have started to lose faith in the government relating to Its monopoly on the money supply.

This monopoly has been a cause of a variety of problems. The ongoing Turkish economic meltdown is a prime example of the government’s mismanagement, which has led the country's people to move away from their currency the ‘lira’.

Srilanka is also not far behind, the poor management, debt policy and corrupt practices have led to severe hardship for the common man. Which include shortage of food, long power cuts and soaring inflation to name a few.

These instances are responsible for the public's growing distrust, which makes them doubt the current system. This has accelerated the coming of various other alternatives, such as a solution given by ‘Satoshi Nakamoto’ after the economic downturn of 2008. The thing I am talking about is cryptocurrencies and the one developed by Satoshi is known today as Bitcoin

Author- Aditya Ohri