Economics 101 (Part 3): Where Does Our Money Come From?

Economics 101 (Part 3): Where Does Our Money Come From?

This may be basic to some people, while others it will be new information. Either way, it's a great refresher.  Again, in order to understand the problems of our economy, you must go the the root of the issue.  The issue is not unemployment, it's not imports, and it's not exports, it simply comes down to the fundamentals of how our system actually works.  It amazes me that this information does not sink in to the population, especially my generation, Generation Y.

As discussed earlier, at one point in time, our money was backed by a hard commodity, something that cannot be faked or easily produced, and therefore the integrity of the United States dollar was very difficult to fake.  The price of the dollar versus the price of gold fluctuated only $0.73 for almost 100 years.  Literally, our money was "as good as gold".

Today, our money can be printed freely by the "Federal Reserve".  The Federal Reserve was established in 1913 through an act of congress (although the details are very skeptical- more on that later).  The "Federal Reserve" as it's called, is the "Central Bank" of the United States.  Essentially, it's a branch of the Federal Government that controls anything and everything related to money and currency including how much money is produced etc etc.

Central banking in the United States

The first paper money issued in the United States was by the Massachusetts Bay Colony in 1690. Soon other colonies began printing their own money as well. The demand for currency in the colonies was due to the scarcity of coins, which had been the primary means of trade at the time. A colony's currency was used to pay for its expenses, as well as a means to loan money to the colony's citizens. The bills quickly became the primary means of exchange within the colonies, and were even used in financial transactions with other colonies.  However, some currencies were not redeemable in gold and silver, which caused their value to depreciate quickly.  The first attempt at a national currency was during the Revolutionary war. In 1775 the Continental Congress issued paper currency, and called their bills "Continentals". But the money was not backed by gold or silver and its value depreciated quickly.  In 1791, which was after the U.S. Constitution was ratified, the government granted the First Bank of the United States a charter to operate as the U.S.'s central bank until 1811. Unlike the prior attempt at a centralized currency, the increase in the federal government's power—granted to it by the constitution—allowed national central banks to possess a monopoly on the minting of U.S currency. Nonetheless, The First Bank of the United States came to an end when President Madison refused to renew its charter. The Second Bank of the United States met a similar fate under President Jackson. Both banks were based upon the Bank of England. Ultimately, a third national bank—known as the Federal Reserve—was established in 1913 and still exists to this day.

^{Officially, the duties and the job of the Federal Reserve are as follows:}

• To address the problem of banking panics
• To serve as the central bank for the United States
• To strike a balance between private interests of banks and the centralized responsibility of government
  • To supervise and regulate banking institutions
  • To protect the credit rights of consumers
• To manage the nation's money supply through monetary policy to achieve the sometimes-conflicting goals of
  • maximum employment
  • stable prices, including prevention of either inflation or deflation
  • moderate long-term interest rates
• To maintain the stability of the financial system and contain systemic risk in financial markets
• To provide financial services to depository institutions, the U.S. government, and foreign official institutions, including playing a major role in operating the nation's payments system
  • To facilitate the exchange of payments among regions
  • To respond to local liquidity needs
• To strengthen U.S. standing in the world economy

^{Now that all the official and formal aspects are out of the way, what's important to focus on is that the Federal Reserve, America's central bank, possesses the sole ability to create money whenever it likes, as well as loan money to the United States Government.  Yes, it LOANS money and charges interest on the money it creates.}

^{As we've discussed earlier, there is nothing stopping the Federal Reserve from printing money whenever it desires.  In addition, the Federal Reserve is it's own regulator, and has very little regulation imposed on it.  So, relating back the the history of money and it's true purpose, you must ask yourself this question.  If one person, or a group of people have the power to produce the medium of exchange whenever they'd like, what happens to the medium of exchange when it's produced out of thin air as is our U.S. Dollar?  It becomes worth less, and less, and less as a medium of exchange.  The consequence is inevitable.  It's simple supply and demand.  If there's more and more money, then the inherent value becomes less and less.}

^{Check out this video for a short explanation.}

More To Come,

 B.