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Price Inflation Graph '05 - '15
Currently No Gold or Silver Standard Currency
There was a time when United States currency would be exchanged for gold or silver. The United States treasury would make the exchange. Our system of money was referred to as a bimetallic standard. In 1964, our government stopped exchanging silver certificates (dollars) for silver ingots or silver dollars (note, Vietnam). In 1971, the United States went off the gold standard, thus creating a purely fiat currency, a currency backed only by faith in the government's ability to pay debts. In both cases because of inflationary fears the value of gold and silver was rising and the government feared losing a significant portion of its stockpile.
Understanding the basics of a fiat currency is important to all of us. The mismanagement of a fiat currency can lead to very serious problems for the average person, not the least of which is severe inflation. A discussion of how fiat money can affect your life follows.
When our currency was redeemable in gold or silver, a person who was worried about inflationary signs (too many dollars in circulation and rising prices) could take and then hold gold or silver. These commodities have been used for money for hundreds of years. Their value tends to rise as inflation spreads. In this way, a person's gold or silver is money that can keep up with or exceed the rate of inflation, thus preserving the purchasing power for the holder. Holding the currency might result in loss of purchasing power.
When inflation is moderated, the owner can then sell the gold or silver (sometimes in the form of gold coins or silver coins minted by governments) which would have maintained its purchasing power versus the inflation. He would get more currency for the gold or silver than currency given when exchanged. This characteristic enables the buyer to then use the currency to buy the same amount of goods and services (which now sell at a higher price) as before the exchange, or as stated above, to exceed that.
Gold and silver have special "trust characteristics"; gold especially so. Currency backed by gold and silver hasn't experienced the same severe swings in value. Swings in a fiat currency's value come from the ease in which governments can create money to pay for programs and other debts (most frequently wars) - money is essentially printed or created digitally with the average citizen at the bottom of the political heap witnessing his hard-earned money going less far. There needs to be a relationship between the amount of money created and the gross domestic production. When currency is created without regard to the disparity between the two, inflation ensues. But, I don't even understand that relationship. This article is for average people like me.
When money is created based on how much gold or silver is in the treasury, the disparities described above don't occur as severely. People are protected by the precious metal. When Wellington contemplated the Battle of Waterloo, he had to make sure he had a supply of gold coins to pay his soldiers to fight Napoleon. Men were more likely to fight and die for gold than for fiat currency. Experiences with fiat currency, especially in Europe, and France in particular, had taught people to be leery of fiat. Today there is no alternative. All of the world's nations have adopted fiat currencies.
At one time our currency had United States Note or Silver Certificate written at the top. This indicated that something tangible was backing the currency. Now we have Federal Reserve Note printed. This indicates that no tangible asset is associated with the currency.
The trust one must have in fiat currency is based on what is referred to as the "full faith and credit" of the United States of America. To attempt to protect one's wealth, a knowledge of misuse of fiat currency can be very helpful. The Yuan Dynasty of China ended the use of fiat money in 1455 to end hyper-inflation. The "Continental" was a fiat currency issued by the continental congress before the constitution, but it didn't explain how a person was to collect the backed money as there was no gold or silver in the treasury. It eventually traded from 300-1000 Continentals to one unit of backed money! From 1790-1799, the French used Assignats. Assignats were backed by mortgages, but there was no control over printing them. In 1799, they were worthless. Other examples include Germany from 1914 to 1923, Hungary from 1945 to 1946, Zimbabwe from 1980 to April of 2008. For 32 examples of hyper-inflation contributing to or caused by fiat money, google "hyper-inflation examples" and read Wikipedia.
To give you another idea of why gold seems to be the standard for money, one can look at financial transactions. Gold is the only metal central banks accept as payments of debts between government central banks. Gold has a pedigree no other metal has. So lacking some sort of backing of gold or silver, fiat currency raises issues of trust. All fiat currencies (no metallic backing) have ended up hyper-inflated in the past.
Preparing for the Future
In preparing for the future, an individual must think about the behavior of his government and factor it in before making financial decisions. Even with regard to something as simple as a checking account or a simple savings account, inflation needs to be factored in, and an appraisal of the fiat currency's current situation made. For instance, if inflation is running at 5% and government influenced interest-bearing checking account rates are .01%, one can see that to protect purchasing power, a different course may have to be taken. One may opt to keep more money in a savings account and transfer when necessary to checking rather than holding a high balance in the latter. If savings account rates are low, one might consider I bonds (inflation protected savings bonds), or the purchase of gold and silver! These are not exotic investment choices.
I have bought some gold and silver from Ebay, but only from sellers with a sizeable number of transactions, and 100% satisfaction rating. The markup in price is probably the lowest available. It isn't hard to find sellers who fit those criteria. However, I would never recommend any investment. You need to learn more about fiat currency and inflation to make your own decisions, as sleep at night is important. If you are someone with small savings, you are the one who can least tolerate irresponsible government policy.
If the government considers issuing a new currency, you can be pretty sure it is an acknowledgment that the government is concerned about inflation. Unless a scheme for backing currency number two with gold or silver is discussed, you can take that as a warning your savings are at risk.
It may be that a penny saved is a penny earned, but that penny earned may be entirely insufficient. Delving into the financial news (as boring as it may seem to you) and understanding the pitfalls of a fiat currency may be very helpful to your wealth health.
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
© 2011 John R Wilsdon
John R Wilsdon (author) from Superior, Arizona on January 27, 2014:
Thank you (once again) for your reply of 1/26/2014
What you have described in detail certainly gives me hope that we can maneuver ourselves to prosperity. Since the entire world uses fiat currencies it may be that the U.S. and its many strengths will guarantee that our economy remains number one on the planet. That would truly be wonderful. Seriously, I want your explanation to hold.
It occurs to me, however, that your thought processes (involving Immaculate Conception and thin air money) are those of a bureaucrat. When I was younger I worked with administrators in public schools who communicated the same way.
As I have said before, I want the U.S. to avoid an economic crisis of great proportion. When debt is an investment and less a future obligation, we should all hope that debt continues. Those treasuries are investments in the U.S. - I get it - but do you think that any other country in the world would exchange gold for U.S. treasuries that China holds?
We are in a sybaritic relationship with China. With emerging markets yearning to escape the bondage of thousands of years of enslavement, perhaps the relationship we have with China will not last forever. That's just a passing observation, not a challenge to your general thesis that the use of fiat currencies need not be a cause celebre.
If you you believe wholeheartedly in the thread that goes through your comments, shouldn't you be 100% invested in the stock market now? That is, it is an investment of shares for fiat dollars.
stanfrommarietta on January 25, 2014:
@John000: "...cyclical nature of "fiat money" - from Fed to bank and back to Fed." Not quite. It starts with the Treasury issuing securities, banks buy them, then banks sell them to the Fed. The chain of causation runs, actually from Congress appropriating money for a certain program, then Treasury determines that it has to borrow to make up a deficit and so it issues securities that must be sold at public auction and big banks usually buy them. (They usually involve a lot of money). Then at a later point, when the banks want their money back and are not content to merely roll over the debt by swapping new securities for old with Treasury, they will put the securities up for sale at public auction, and the Fed at this point will buy them (especially if there is deflation, like now). The Fed buys with money it creates out of nothing, That redeems the debt to the banks but does not extinguish the promise to pay full value to the holder implicit in the securities. The Fed is not owed the value of the securities because it is only an agent of the government buying with government money. Fed swaps its mature securities for new ones with the Treasury. Fed sells new securities to banks to drain (for the time being) their reserves if there is inflation.
But also, and this is what I call "immaculate conception," the Fed cannot buy securities directly from the Treasury. A law prohibits that. But by buying the securities from an intermediary--the banks--it redeems the debt implied by the deficit spending money obtained from the banks. Furthermore because buying the securities from the banks restores (relatively speaking) the reserves of the banks to what they were before they lent money to the government, the deficit spending money can be treated as if it is the new money created by the Fed. (Money is fungible. Look up the word in the dictionary). So the Fed is able to create immaculately the deficit spending money without directly touching the Treasury. So deficit spending money as new money in circulation can give a boost to the economy that is in a recession or depression.
Elsewhere here I have commented on why this need not be inflationary during a recession.
The Chinese have a fiat money system and understand and use it better than we do. So, they understand that with a lot of dollars from exports to WalMart they need a safe place to keep that money and earn some interest. Buying Treasury securities does that. Our government can always redeem any size debt because we have fiat money the government creates. And we essentially keep their dollars safely at the Fed in time deposit accounts corresponding to the securities. The benefit we get from that is we keep those dollars out of circulation when they could be destabliizing and inflationary. Perhaps the Chinese don't want to upset the applecart of our negative trade balance with respect to them. If we got mad and raised tariffs on their goods it would hurt their rapid economic expansion. Gold has dropped in price and now may be a better time to buy it, not for monetary purposes but for industrial use. It also makes gold scarcer for the rest of the market causing a rise in price. Who knows?
But it is a myth that our government is borrowing from the Chinese to fund our government's operations.
That borrowing is done with American banks. The Chinese are investing, not lending.
stanfrommarietta on January 24, 2014:
Here's an update on my previous post on the nonproblem of the national debt:
I've since learned that the securities held by intragovernmental agencies, like the Social Security Trust Fund, are not marketable. These are intragovernmental securities. Furthermore the Fed cannot by law buy them directly. So, my saying so as a way to return money to the Trust Funds was wrong. But still no problem.
All the Treasury has to do is to issue marketable securities equal to the value of the intragovernmental securities from the Trusts to be cashed in and take the money from the sale to banks and pay the Trust Funds the cash for their securities. That redeems the debt to the intragovernmental agency.
Aha, you say, but that just created a new debt, the debt in the securities held now by the private banks used to get cash to pay the agencies.
That is still not a problem. It does it this way to set things up so that the Fed can buy the securities, because these will be marketable securities the Fed can buy at auction. So, when the Fed buys these securities, all debt associated with the securities from the Trust Funds is eliminated. The securities now go to the Fed and do not have at this point a holder of them that bought them. They are still 'live" in the sense that the promise to pay a holder of them their face value is still in effect. But the promise is between the government and the holder (presumed not to be a lender to the government). The Fed is an agent of the government in this. It is not owed for holding the securities. To claim the Fed is owed for the securities would be like a bank clerk claiming to be paid for the value of securities he/she bought from a bank customer with bank money for the bank. So as with all marketable securities bought by the Fed and stored at the Fed, they do not represent live debts. A live debt would be where the holder is an entity that bought the securities and gave the government money for them and now holds the securities. That is different from the so-called debt or liability in the securities themselves. They are assets as well as liabilities of the government: the promise to pay face value to the holder on demand. But first, for this to be more than a potential debt, the securities must be sold to someone. It's the same as the liability on a dollar bill. You take the dollar bill to the Treasury and ask for something comparable in value and you will get another dollar bill back. You take a mature Treasury security to the Treasury or the Fed and you can exchange it for the face value in dollars of the security.
Another observation that I just realized after my previous message. When investors park their dollars in time deposit accounts at the Fed in return for a marketable security from the Treasury, they are keeping those dollars out of circulation, thus serving a deflationary function. There are around $600 Trillion in the world. Most are in savings somewhere and not in circulation. (The national debt is only about $17 Trillion.) Hence they are not currently inflationary in our country. The Chinese who hold over $2 Trillion in securities in account at the Fed, are not spending those dollars buying goods and services along with everyone else, thus driving up prices (assuming production cannot be increased with hiring more workers at stable prices and wages). Inflation only occurs when money is used to chase goods and services. Money in savings accounts are not circulation. And the Chinese money is NOT used to fund government operations. It just sits in an account at the Fed. So, in a way the national debt is largely deflationary, taking dollars from private and foreign investors and socking them away to where they cannot cause inflation.
The Treasury can get any money it needs to cover deficit spending by borrowing from American banks, so no need for foreign investors to lend our government money for its operations. And it is limited to borrowing only what is authorized by Congress. Of course, we would prefer that during a recession here in the U.S. that foreign investors would buy some of our produced goods and services with their dollars. That would help get us out of the recession. Exports and deficit spending put additional money into circulation. Deficit spending creates new money (once the securities for deficit spending get around to being in the hands of the Fed).
So, taxpayers do not have to pay off the national debt. The Fed can do it without working up a sweat.
And in fact, it is being paid off all the time by the Fed or rolled over indefinitely by Treasury swapping new securities for mature securities. Ultimately they will be sold to the Fed when the banks need the increase in their reserves.
stanfrommarietta on January 19, 2014:
One thing that bothers me about the way people treat the national debt is that they do not look closely at what the debt consists of. Take $12.5 Trillion of the debt in the private (public) sector. Almost all of those are private and foreign investors e investing and not lending. The securities held by them are like bank CD's, time deposits. Their money is always there to pay them back plus interest (created by the Fed). We do not run our government's operations on money borrowed from abroad. Our debt for deficit spending on government operations is done with securities sold to large US banks and financial institutions at public auction. All deficit spending is funded this way. The Fed buys these securities when banks put them back up for auction (and there is deflation). That redeems the govt.'s debt to the banks. The securities however still carry the implicit debt of a promise to pay the holder their face value at a future date. Mature securities at the Fed are just potential not actual debt because no one lending the govt. holds them. The Fed will swap these securities for new ones with new future dates and interest and sell them to banks to drain their reserves. So the securities at the Fed don't really represent debt to any actual lenders . The Fed really isn't owed the full value of the securities because it is government by acting as a government agent. Government doesn't owe itself.
Suppose I told you that the large national bank you bank with is billions of dollars in debt. Do you think it is about to collapse, go bankrupt? The "debt" is just all the deposits at the bank that the bank is liable for. And the bank cannot use those deposits for speculation or purchase of goods for its own benefit. We know that the bank will have the deposits to return to their depositors.
Well, scale that up in considering the national debt. Most of it is time deposits corresponding to securities bought by investors. These are kept in accounts at the Fed. When investors have mature securities they can demand their money back plus interest, and it will be there, with interest created by the Fed. This happens all the time. They know that if anything went wrong the Fed would be able to create their money and return it to them. That's why Treasury securities are such safe investments, even safer than securities issued by businesses or private banks. Their securities can also roll over their debt by the Treasury swapping new securities for mature ones. It's like rolling over a CD at the bank.
So Fed has securities that no lender holds and are only potential debt until sold.
A big proportion of private debt is foreign and private investors with time deposits backed by securities.
What about the government trust funds and their securities? Well, it seems to me that if and when the trust funds need the money, they can just put the securities up for sale at public auction and the Fed will buy them. They don't need to cash in all of them all at once so cashing them would not likely be inflationary. In fact they would be replacing money already in circulation that was no longer available. Without such infusions of money, there would be deflation. In 50 years, I understand that Social Security will still be able to pay 75% of the benefits from current FICA taxes collected. The rest would be made up by drawing down, when needed, cash from their securities, sold at auction. At that time we may add money to the Trust Fund from deficit spending.
One other thing: the fact that the Chinese have tied up trillions in US securities means those dollars are being kept out of circulation here and not causing inflation.
Nowhere in this do we see taxpayers being required to pay down these 'debts'. We have fiat money created or sanctioned mostly by the Fed.
I haven't looked into exactly why we have what you call 'biflation'. I know that economists would not recognize it as inflation. Inflation has to be a general rise in prices across the board. It could be that the vendors of products you mention are trying to make bigger profits. There are also scarcities due to drought, more players in international markets and speculators who buy up commodities and hold them until their prices rise.
John R Wilsdon (author) from Superior, Arizona on January 19, 2014:
"Government shouldn't be deficit spending when interest rates have been set high to combat inflation. " But it does.
OK. Ultimately the Fed controls the money supply and we will never have to pay the debt all at once. So it is faith in the Federal Reserve to manage the money supply effectively and keep track of mounting book debt that will keep the economy from collapsing. We have more to fear by saying "the sky is falling" than anything else? I have never said that - only that "something isn't working too well" from an employment standpoint.
We now have BIFLATION. We have inflation of those things people need, like gasoline, heating oil, bread, rice, cereal, beef, pork, chicken, chemicals, ............! We have deflation in those things companies can't sell enough of like PCs, microchips, processors, etc. If wages do not rise folks will require mostly the inflated goods. And many things have been shrinking - it is amazing how many things are shrinking while prices stay constant, and anyone going to the grocery store can see that daily. I think we have inflation problems now that are way understated.
The shape of the containers can fool you unless you read the volumes, so it is less noticeable. I know that items are being packaged in obviously new WAY smaller containers for less because folks can't afford the other sizes. Glue is an example. I do nearly all of my own work, and all sorts of things are being sold now in small sizes I have never seen. Check out paint thinner. It goes on and on. That's inflation and an inability of wages to keep up with price.
Warren Buffet is on record having said that he wanted Ben Bernanke to continue as Fed chief because he had done a good job and he (Buffet) wanted to see how he was going to deal with the issue you speak of (and given the near collapse of banking, I think he is right) (But apparently you think QE can go on indefinitely as long as unemployment stays high) :
("and I am trying to get clarification on this from the Fed") the Fed eventually will buy back these securities at public auction when there is deflation (like now)". Not sure about that.
I hope you are right and all works as you say. That would truly be wonderful. It would be great to see a clarification from the Fed too, but I am betting you will never get one. I don't think the Fed knows exactly how to deal with the issue of capturing so many dollars.
Perhaps if enough of the world owes large quantities of money, it won't matter in the end. It might be that the only thing the U.S. needs to be concerned about is staying strong and not mismanaging, regardless of what it owes.
Roosevelt's 1933 gold confiscation was apparently not necessary, or was it necessary because other countries had gold backed currency and that doesn't exist now?
And yes, banks have lots of money and I use a bank. But I use it because I have nothing else to do but keep money in my home and burn gas paying bills (it's $3.20 a gallon and for a number of reasons I do not think we will see gasoline under $3.00 again). I don't feel comfortable using a bank because they have tons of money.
Questioning all of this simply means I have doubts. Your certainty about this is refreshing. Thank you for the thoughtful explanations.
stanfrommarietta on January 18, 2014:
john000: "I do fear a time when banks call for their cash while the government finds itself paying high interest to finance the deficit. "
Do you think that kind of thing would occur? Government shouldn't be deficit spending when interest rates have been set high to combat inflation. In fact the high interest rates inhibit government from deficit spending because it has to borrow first to do that deficit spending. Even so, the Fed can pay any interest rate, so it ends up winning at the auction when the securities at maturity come back on the market at the auction. The Fed can pay face value. Everyone else will want to pay less than full value and will gravitate to situations where they can make more.
stanfrommarietta on January 18, 2014:
Actually the so-called "national debt" is now around $17 trillion. I believe it is counted by adding the values of all Treasury securities issued by the Treasury now in the hands of both public (government) and private holders.
Would it bother you if you learned that your bank was billions of dollars in debt? Well, if it is a large national bank, it probably is. You see, debt is just a liability. A bank has liabilities to those who have deposits in the bank. The bank has to pay them back what they deposited in the bank. So, the sum total of all deposits in the bank represent a debt of the bank to those depositors.
A large part of your bank's liability are to holders of CD's. CD's are time deposits of investors who seek a relatively safe depository that will earn them interest. The bank does not use the deposit money for its own speculation or buying of property or goods. So, the money is still there or replaceable by the bank. So, the huge debt is not really something out of control.
If you understand that, you are now in a position to understand the true meaning of the national debt.
A huge part of the debt is to private holders of Treasury securities. Most of these are just investments, like taking out CD's in a bank. Treasury securities are perhaps the safest investment in the world. They may not pay much now in interest but in a world where there is risk, in stocks, badly run banks, Treasury securities are the closest thing to absolutely safe. Why? Because the federal government has the power to create any amount of money it needs to pay back a debt. The government cannot run out of money--as long as it is not hampered in the exercise of its powers given to it in the government to borrow money and pay debts.
What about China "lending" money to our government? They are not lending money to our government. They are investing their pile of dollars obtained through our buying imports from them in an ultra safe investment: Treasury securities. Think of the private holders of securities as investors. The government is not borrowing from them. It is making available a safe haven for their dollars in the form of US Treasury securities and bonds. The Chinese have a fiat money system like we have, and they understand that there is no risk of insolvency for a government with such a system. So do many foreign governments and institutions who hold US Treasuries.
And any time one of these investors in securities wants to cash in its securities, the Fed (which is our government's bank) which holds the deposits for the securities will just return the money to the investor plus whatever interest is owed. It may even have destroyed the original dollars invested, because no need to take up a lot of storage space keeping all these dollars available. The Fed will just create new money to replace the old and give it to the investor on demand (with interest).
Now, it is true that the US government "borrows" money from banks to fund deficit spending. It also uses Treasury securities to do this by selling them at public auction to banks. Banks buy at discount and the government redeems the securities at maturity (some designated future date after sale) at face value. The difference between the original sale price and face value is interest earned. Now days with interest near 0%, interest earned is not very much, but it is nonnegligible on large loans. This is funding the Federal government.
Now, I think, (and I am trying to get clarification on this from the Fed) the Fed eventually will buy back these securities at public auction when there is deflation (like now). The Fed will purchase with money it creates out of thin air (it is the government's money creator) deposited in the reserve accounts of banks kept at the Fed. The Fed gets the securities back for the government. That should cancel the debt Treasury created for the government to the banks. Banks no longer hold the securities and they have gotten their money back paid for with government money. So if it looks like a payoff, walks like a payoff, it is a payoff. The Fed is an agency of government, kept insulated from political influence (they say) by not depending on Congressional appropriations for its operations and actions. Fed is funded by transaction fees on its various purchases and sales of 6% of the interest earned by the holder.
They say that today about $4.995 trillion are in intragovernmental holdings of securities. That includes the Fed, and numerous government agencies who have put excess tax money and fees they have collected in the purchase of securities. These again are like time deposits, CD's.
The Fed's securities still retain the liability to pay to a holder of them who has lent money to the government in return for the securities the face value of the security upon maturity. Most of those at the Fed were acquired when they matured at the banks. But the fact is, that at the Fed none of those securities are held by anyone who has lent money to the government. They are in limbo, in storage, waiting future use.
A time will come, when too much money is circulating to clear all the goods and services at stable prices and full employment. That will be inflation. Then the Fed will go to the Treasury, swap mature securities for new and then sell these to banks to drain their securities of excess money. This will dampen the inflation. (This is not the only way the government will seek to control inflation: raising taxes, cutting government spending, encouraging imports and savings will be other ways). So, that is why the Fed keeps these securities. The Fed has about $1.794 Trillion in securities.
The Social Security Trust Fund is the largest governmental holder of these securities. It collected lots of FICA taxes and then invested this in Treasury securities to earn interest. It has $2.764 trillion in securities.
None of these will have to be all cashed in at any one time. The SS Trust will cash in when needed sometime in the future to get funds to supplement what then will come in taxes to pay benefits to the baby boomers. They will not cash in everything at once. It will not likely be inflationary to any significant degree. And who will pay them back? The Fed. All the SST needs to do is put its mature securities up at public auction and the Fed will buy them back with money created out of thin air.
There is never any need for taxpayer money to pay for this.
So, if you are not now concerned that your bank has billions of dollars in debt to its depositors, you should similarly have no concern that our government has some 6.5 Trillion in 'debt" to private investors. The Fed will pay them off as they seek to cash in their investments by turning in the securities. Again it will create the money.
You also should not even think of the "debt" at the Fed as live debt to a particular lender of money to the government. The Fed's debt is just the potential liability, like your bank's potential liability, to pay the holder of the securities at some future point if and when the securities are sold to some banks.
There is no national debt problem. Stop running around like Chicken Little crying, "The Sky is falling!"
As for dangers of inflation, that would only be serious if the government had to pay back all of those securities at once. But it won't. And even if it did it would go into action to control the inflation by selling more securities. The Treasury would also sell a lot. And most investors do not all demand redemption of their securities at the same time. They would if the government showed it would not pay its debts.
The Treasury also has ways of putting off pay-off of the securities. It can negotiate with private investors whether they would like to roll over their securities: swap new securities for mature securities. In this way the debt can be carried indefinitely through centuries if need be without ever finally paying it off.
Taxpayers are not involved in paying off the debt.
John R Wilsdon (author) from Superior, Arizona on January 15, 2014:
Thank you for the detailed explanations of the utility of fiat currency.You have spent a good deal of time explaining in detail the (for want of a better description) cyclical nature of "fiat money" - from Fed to bank and back to Fed. A person reading your comments would get a good lesson in how it is supposed to function. I guess that it all boils down to the full faith and credit of the United States government. But what I see from what is going on is less faith in the dollar. Don't underestimate how much I am thankful of your careful thought process. Thanks.
Banks are currently buying treasuries and paying at discount, yes. But they get the face value or par at maturity (including their interest profit). This has been lucrative for the banks, especially since they have been afraid to loan money to small and large business. That may just have turned the corner, and I hope so. I do fear a time when banks call for their cash while the government finds itself paying high interest to finance the deficit. The money from overseas has dried up because of fear of devaluing of the dollar. That interest would be paid through increased money supply. If interest rates rise, that means employment is better and we have increased growth. With that comes demands for higher wages and ....... inflation. Now, I will not argue with economists that we need 2% inflation, and Mr. Bernanke seems fixated on that. But I have seen things get OUT OF CONTROL very quickly when it comes to government financing (and crooked bankers, sure).
In a world of fiat currencies, the desire for that currency is based on political stability, in my opinion. That is where the perceived value is. When all of our spending is paid for by a "printing press" the view of our economic system comes into question. By creating money out of thin air and simultaneously losing foreigners faith in the system, it seems to me a very tight rope. The Chinese have so much in U.S. dollar reserves that they are not interested in the dollar much anymore. Perhaps the fact that they don't understand fiat currency managed at its best is why, but that seems a big problem. Instead of treasuries they buy gold.
Yes, money supply has got to increase due to increase in workers and increasing gross national product. But $16 Trillion is a lot of money, and to be honest, I can't imagine without some kind of calculation what it means! So our growth per year is pretty measly compared to the increase in the amount of debt on the books.
After WWII we owed a ton of money to other countries which was converted into those country currencies. They didn't hold all of what was due in reserves. But we inflated what we owed away. So we paid with more and cheaper dollars. And yes, they turned around and purchased a lot of stuff from us because most were bombed out. Today, we have cheapened our dollar already, so allowing inflation to whittle away more to pay the debt would cheapen it, I think, dangerously. We aren't exporting as much as we import.
With the amount of gold the Chinese are buying with our dollars as fast as they can, I have a feeling that they plan on backing the renmindi at least partially with gold. Whether that will help it become some part of a new reserve currency is the question. Suddenly, in addition to the inflation we may have unwittingly created, and the drop in value of the U.S. dollar, there might be trouble in the kingdom.
I am not personally sold on a liberal or conservative view of money. What I fear is excess by either side. And since I am fundamentally a conservatively natured person, folks like Paul Krugman make sense to me one minute, but not the next. But I do understand what you detailed above.
To give you an example of the tossing and turning I do when thinking about this, have you heard of Bitcoin? Now there is another thing (cryptocurrency) that I still cannot get my head wrapped around. If you have wrapped your head around it, I suggest you write a hub. I will be the first to read it. To be honest, you could explain the theory of money as you have explained it above with a wonderful hub.
Thanks again for all of your insight. John
stanfrommarietta on January 15, 2014:
I think this is happening all the time. No big deal. So, this is not something I am suggesting should be done and laws need to be passed to do it. It's already possibile within the law. The problem is that Americans need to learn how their government's finances work. They are trying to understand it using false analogies to household finance, business finance, state and local government finance. That is something they are most often familiar with. But the Federal government is different. It creates the money and spends it.
If you worry about how people will misuse it, then, yes, that is possible. But so far we have not misused it. We have not had major hyperinflation. We have more often had recessions and depressions. And I concede that the private sector has been mainly responsible for these (except for a little recession that resulted when President Clinton created a surplus, taking more money out of circulation via taxes than was spent back into circulation by government spending.
And yes, the regulation of banks and other financial institutions has been horribly lax. A lot of that is indirectly due to bankers and neoclassical economists being lulled into thinking that the market will always correct itself and return to equilibrium. Thinking this leads them to think government shouldn't regulate; so, they didn't, and look what happened to the housing market and all those CDO's and default swaps.They never saw the Great Recession coming!
The problem is that when we have a period of good times and prosperity, we think there are no dangers in our economy, and we start taking bigger and bigger risks. That's just the lull before the storms.
stanfrommarietta on January 15, 2014:
You are right. But what I am describing is what is happening all the time. But it can get all screwed up if the Tea Party GOP tries to make the Federal government into a State government, which cannot create its money and require citizens to pay taxes to it in that money which makes the government's money needed. So, I am not describing something that should be done in the future. I'm trying to open up the obscurity that surrounds how our Federal government's finances work and are different from that of households, businesses, or state and local governments. We don't need to continually screw ourselves because we have the wrong analogies (households, businesses, state and local governments) for understanding Federal finances. Your argument goes beyond money to democracy itself. Is democracy really functional? Can ordinary people govern themselves without making huge mistakes that cost them their freedoms? If we let this country run down through austerity, the Chinese will roll right over us with their powerful economy, and maybe even their military.
stanfrommarietta on January 14, 2014:
I think your objections to fiat money are that it tends to inflation. But where is the inflation that was not nipped in the bud after 1971 when Nixon took the dollar off the gold standard? Your pessimism about human nature is well-taken, but the fiat system we now use has controlled inflation so that it does not cause serious difficulties for society as a whole. In fact, economists think 3% inflation per year is necessary to keep people spending rather than locking all their money up in some bank somewhere. If you think you will gradually lose value if you continue to save, you will spend it. The Japanese have a national debt twice their GDP, but little inflation. In fact, they have had some deflation. Part of their problem is that the Japanese are obsessive savers, planning for their retirement. The government has to keep entering new money into the economy to keep the amount of money in circulation sufficient to maintain stable prices and full employment. They also have a problem of huge negative trade balances, because they have to import much of their raw materials for industry and energy (oil, natural gas, etc.). That also drains money out of circulation in the economy, which must be replaced by the government. Money is just a necessary ingredient for economic exchanges. All it is is a quantitative representation in units of account (e.g. dollars) of relative debt obligations between parties in the economy. Without some way to represent these debt obligations in an objective and clear manner, one cannot have economic exchanges. But a nation sovereign in its money system will establish a monopoly of money. And if it is concerned with the general welfare of its people, it will attempt to maintain stable prices and full employment. And only by requiring that people pay the government taxes, fines and fees for services, in the government's money, you get people wanting that money, and having a common medium of exchange facilitates exchanges. I think most austerians exaggerate the problem of fiat money generally. The case of Weimar Republic of Germany after World War I and Zimbabwe used to illustrate hyperinflations ignores the fact that these people had debts to foreigners in money other than their own. Even Argentina struggles because it tends to peg its money to the dollar. A government that allows its money to float freely on international money exchanges does not have the problem of people trying to sell their money short.
stanfrommarietta on January 14, 2014:
So, now we have the Fed having bought securities from banks. The banks got the securities when the Treasury needed money to cover a deficit in Congressional spending. The Fed bought them with money created out of nothing--well, it is the money creator in our financial system. Where do you think money comes from?
At this point we should focus attention on what happened to the money that Treasury got from the banks in exchange for the securities. It was spent on programs authorized by Congress. It is money now circulating in the economy. Once the Fed has bought the securities that generated the money Treasury got, the government no longer owes the banks the money for the securities The Fed being also government, like Treasury, has gotten back the securities for the government. It has used money created by government power granted to Congress in the Constitution (Art. 1 Sec. 8) and delegated to the Fed to buy the securities--government money. So that redeems the debt to the banks.
The fact that money is "fungible" (definition: being of such a nature as to be freely exchangeable or replaceable by another of like nature or kind), we can equate in our minds the money the Fed deposited in the banks' reserves with the money the banks gave the government for the securities. It is as if instead of the Treasury issuing securities, the Fed just gave the Treasury the new money it needed to cover a deficit. The banks are just back to what they were before they bought the securities. So, the deficit spending at this point is spending new money for all practical purposes. And it might be inflationary or may simply allow the economy to grow back without inflation, depending on whether the economy was already at full production with full employment or was at less than full production with lots of unemployment.
You may be wondering why the use of banks as go-betweens for the Treasury to get new money for deficit spending. Well, when the Federal Reserve was created the writers of the law creating the Fed in 1913 wanted the Fed to be independent of political influence, so that it could make its own decisions about what the economy needed (although it is not clear that the Fed always knew what was best beyond Congress). So they said that the Fed could not buy securities or give money directly to the Treasury at its request. Much later the Treasury was specifically prohibited from having an overdraft at the Fed.
Furthermore, the Fed does not depend on Congress for appropriations to do its work. It is funded by transaction fees of 6% of the interest on each security bought or sold. So, the Fed is said to be an "independent entity of government within the government".
The Fed also at this point has the securities it bought back from the banks. These are still live, but without any holder that lent to the government, so they are not really indicators of debt, but only potential debt. The Fed will use these securities to control the money supply. If there is excess money circulating causing inflation, the Fed will swap mature securities it holds for new securities from the Treasury. The Fed will sell these new securities to banks to drain their reserves of money. The Fed will just sit on these securities until they mature. In the meantime the banks will cut back on their lending so as to not out run their back-up reserves. And inflation will tend to cool. (There are other forces besides Fed and Treasury that will also tend to stop inflation).
The Fed will want to get securities back to swap for new with the Treasury during deflations. It will do this by buying back securities from the banks to put new money in their reserves. The money lent by banks for the securities is now like new money in circulation. This will counter the lack of money in circulation producing the deflation.
Ultimately, though, it all depends on Congress authorizing spending whether we have deflations (like now) or inflations. Treasury cannot spend more than Congress authorizes. Treasury cannot deficit spend unless Congress spends at a high enough level that cannot be covered by taxes. But raising taxes will likely not help an economy get out of a recession or depression, beause that takes money out of circulation, or doesn't change what is in circulation. It takes spending new money, and that will only occur when the Fed buys securities used for deficit spending from the banks with money it creates out of thin air. So Congress also has to spend more than the government is taking in in taxes--deficit-spend--to get the country out of a recession by introducing new money into the economy.
stanfrommarietta on January 14, 2014:
johnoo:"Yep, this digital age does seem to introduce new puzzles. When numbers are exchanged electronically it is hard for an average person to keep track of. But, eventually those numbers will turn into paper dollars. I once heard an economist say that the money supply was not being affected by all the government spending. Stuff was being paid for by selling "treasury bonds". I think he meant what you imply, that the bonds were digital entries with no increase in money supply. But if that is true, what are the bonds exchanged for? Are they exchanged for more digital inputs? If true, doesn't that mean when people demand money for their bonds there will be an increase in money supply? And if the government goes into default, treasuries on the secondary market will be selling for LESS. I don't pretend to understand the subject. The whole thing can make an average person dizzy. I think that is part of the attraction of gold and silver. There is an assumption that because of its rarity, and in silver's case, industrial needs, the two will always hold their weight as money. Your comment perked my ears, so if this is more like a hub than a comment, I am sorry. Sometime I like to voice what confuses me, and answers from the government frequently confuse me. Thank you for your commment."
Paper dollars are a very tiny portion of our dollar supply. There are trillions of dollars that are essentially electronic, digital entries being transmitted back and forth in the world economy. The Fed, when it buys Treasury securities (bonds) from banks, buys them with newly created money created out of thin air as it enters the amount of the purchase in the spreadsheets for the reserves of the banks kept at the Fed.
Do you understand how securities and bonds work? They are essentially IOU's, but the IOU is not written to any given person. "The United States promises to pay the holder of this security the face value of this security on or after dd of mm of yyyy." That allows the IOU's to be sold and traded. These are sold at discount for less than face value at public auction. The highest bid less than face value is usually the one that takes home the security. The interest to be earned is the difference between the price the holder paid for the security and the face value at redemption time. A security is said to be "mature" when the redemption date has come or passed. So the value of a mature security is the face value. If it is for $25,000,000, that is what it is worth in dollars, and the mature security and the dollars are exchangeable. Securities are devices for transferring money from one party to another in return for a promise by the second party to repay the "lender" at some future date in return for giving the security back to the second party.
Well, the economist you mention was partly right. The money supply is not effected at first when the Treasury issues and sells securities at public auction in return for money to be used by the Treasury in deficit spending. Banks get the securities and in return they give (loan) the Treasury the value they paid for the securities, which is discounted from (less than) the face value of the security. So the money supply in the economy has not changed in quantity as it was transferred from banks to Treasury. That represents a debt of the government to the banks. But it doesn't end there, because the debt has to be paid.
There are two ways (as I have been able to glean them) by which the government does this. In the first case, especially if the holder of the security is not a bank but a private investor, the Treasury can reach an agreement with the holder to swap a new security for the mature security held by the investor. A new future redemption date comes with the new security. There may also be a specified interest rate based on the market that the Treasury will pay on this new securithy. This operation is called a "roll-over". The upshot of this is that the debt will never be repaid, and the holder is making money on the interest. Of course, at some point the investor may want all his money back. At that point the Fed may step in and simply refund the money the investor had on deposit at the Federal Reserve Bank plus any interest earned. In this case the securities are like bank CD's or time deposits.
The second way more likely will involve the Federal Reserve and the banks holding the securities. Back up for a moment: The Treasury had a Congressional deficit to cover. That meant the amount Congress wanted to spend was more than the money the Treasury had from taxes. So, the Treasury issued securities and sold them at discount to banks at a public auction. That's how the banks got the securities.
The banks will put their mature securities up for public auction and the Fed will buy them. It buys them with new money created out of thin air. It does this by writing in the sum of the original reserves plus the purchase price of the securities in the banks' spread sheets for their reserves at the Fed. (All banks have their reserves recorded at the Fed). So the banks' reserves grow with the amount of the securities sold to the Fed. This creates new money and increases the money supply.
John R Wilsdon (author) from Superior, Arizona on January 13, 2014:
Regarding your comment of Jan 12-
Much of what you have discussed about what the Fed can do and why fiat currencies are good involves the word "CAN". The problem is that it is so rare, and in some cases never has been. I know unemployment is a bad thing, but favoring fiat currency for its positives "if" politicians, regulators, and the rest would do those things is a weak argument. It seems a fairy tale to believe that anyone will raise taxes and not spend them? Yes, the Fed has control over interest rates and has tools to use, but destroying the dollar and confidence in the system by over tweaking is something that is hard to undo. The Fed's medicine may become a terrible poison. We shall see. Thanks for the comment.
stanfrommarietta on January 11, 2014:
I find that those wanting to go back to the gold standard like that idea because it maintains stable prices. But the bad thing about that is that it ignores unemployment. Unemployment is worse than modest inflation in its effects on people's lives. Furthermore, it ignores the fact that there are numerous ways in which a fiat money system can control for inflation. Taxes can be raised and not spent. Imports can be encouraged to take money out of the national economy. The Federal Reserve can sell securities to banks at higher interest (to induce them to buy) and thereby drain their reserves and the strength of their lending position.
(They will reduce lending). Deficit spending can be cut or eliminated (for the time being). People can be encouraged to save by giving tax breaks for things like IRA's and 401k accounts. Interest rates can be raised to discourage borrowing while encouraging saving to earn interest
But fiat money systems have flexibility to deal with deflations which it is harder to do with commodity backed money. It is easy to create new money to replace that which has been lost from the economy or not added during economic growth, causing the deflation.
John R Wilsdon (author) from Superior, Arizona on July 17, 2012:
monicamelendez: With all the latest revelations about the habits of banksters and the rest of their ilk today in the United States, I would say you are right, have it in your hand. I just read an article detailing how the large banks have been sending questionnaires to popular analysts and getting responses in order to figure out what their views probably are before the public can hear also. ETFs don't have enough metal to cover all liquidations, yada, yada.
Dig a hole and bury it; just don't forget where you put it!!
monicamelendez from Salt Lake City on July 17, 2012:
Gotta buy gold! Real gold, not 'gold' in some account somewhere.
theking2020 on February 13, 2012:
The two best investments of all time, and forever is gold and silver.
Caerleon on January 03, 2012:
It is an unfortunate fact of paper money that it tends to become backed by nothing more than empty promises from politicians and the ability of central banks to manipulate prices through inflation.
That is not to say that gold is not without its problems, but the finite supply of the metal does make it very appealing as a form of currency (not to mention its intrinsic value with regards to things such as jewelry)
Even a return to paper currency backed by gold would be a good start. If not, we could soon find ourselves experiencing the "Weimar" effect.
Caerleon Team from http://howtoinvestingold.org
Ahyat from Canada on December 19, 2011:
Great hub, theirs a lot of valuable information. keep it up ;)
John R Wilsdon (author) from Superior, Arizona on December 08, 2011:
Yep, this digital age does seem to introduce new puzzles. When numbers are exchanged electronically it is hard for an average person to keep track of. But, eventually those numbers will turn into paper dollars. I once heard an economist say that the money supply was not being affected by all the government spending. Stuff was being paid for by selling "treasury bonds". I think he meant what you imply, that the bonds were digital entries with no increase in money supply. But if that is true, what are the bonds exchanged for? Are they exchanged for more digital inputs? If true, doesn't that mean when people demand money for their bonds there will be an increase in money supply? And if the government goes into default, treasuries on the secondary market will be selling for LESS. I don't pretend to understand the subject. The whole thing can make an average person dizzy. I think that is part of the attraction of gold and silver. There is an assumption that because of its rarity, and in silver's case, industrial needs, the two will always hold their weight as money. Your comment perked my ears, so if this is more like a hub than a comment, I am sorry. Sometime I like to voice what confuses me, and answers from the government frequently confuse me. Thank you for your commment.
John R Wilsdon (author) from Superior, Arizona on December 08, 2011:
Your quote is great, and I think it is right on. It seems to me there must be something else besides paper that could be universally accepted for money to keep a check on currency, otherwise, there is no check on politicians and the Fed. They have the power to single-handedly ruin an economy. Thanks for the comment, and I hope things in the U.S. come to fruition better than I expect.
againsttheodds on December 08, 2011:
Great article. This is another issue where there is only one honest politician who will attempt to put an end to the US government's wreckless ways. Regarding Ron Paul from wiki: He opposes dependency on paper fiat money, but also says that there "were some shortcomings of the gold standard of the 19th century ... because it was a fixed price and caused confusion." He argues that hard money, such as backed by gold or silver, would prevent inflation, but adds, "I wouldn't exactly go back on the gold standard but I would legalize the constitution where gold and silver should and could be legal tender, which would restrain the Federal Government from spending and then turning that over to the Federal Reserve and letting the Federal Reserve print the money."
style-of-life from Netherlands on December 08, 2011:
Great article. One wonder where it may lead when currency is no longer printed, just virtual money floating somewhere. Not highly unlikely, with NFC (paying with your phone) coming up.
John R Wilsdon (author) from Superior, Arizona on November 27, 2011:
And thanks for the comment. Yes, I do see what you mean. Somehow when I try to think about a collapse and all, my stomach gets involved with the calculation. Perhaps canned beans would be a good currency to hold?
MobyWho from Burlington VT on November 27, 2011:
This continues to be a debatable subject. I can remember thinking "you can't eat oil" back in the '70s...and look where oil has gone - Up, up, up. Of course a lot of that increase is taxes. I'd rather try to take care of several bars of gold than an equal value of a perishable item.
htodd from United States on November 26, 2011:
That's really great info .Thanks
john000 on August 07, 2011:
You state, "My guess is you would do just fine if you had to go out and hunt quail or venison."
Thanks for the comment. Plenty of mule deer and quail around my neck of the woods. Take care.
True Cures from Payette Idaho on August 07, 2011:
LOL, I have a completely different opinion as to what is wise if the world economy crashes. Most of my friends are stock piling guns, ammo and food. Me I'm trying to set up a self sufficient life that will provide food and shelter by daily work.
I don't think any amount of guns and ammo will protect a stockpile of food or money for that matter. People have to sleep and who wants to sit on guard for the rest of their life.
On the other hand, how many people are going to be willing to sit by and wait for a fruit to ripen or an elk to be harvested and prepared.
I have no illusions, I know it would be ugly all around but I also know that with today's media and the way the market is manipulated that it is highly unlikely that gold will ever become second or third to food and water.
There's two kinds of hunting, sport hunting and subsistence hunting. Sport hunting requires fine camo clothing, super high powered rifles or bows with superior optics like scopes and binoculars. Basically an investment of anywhere from $5,000 to $20,000. Hunting for food only requires know-how and will almost always be more effective than hunting for sport. Maybe that's only an opinion. My guess is you would do just fine if you had to go out and hunt quail or venison.
Gold is a good worthy business, not to be knocked. I just like people to keep in mind that it only works as long as we are convinced it works.
John R Wilsdon (author) from Superior, Arizona on August 07, 2011:
You have a good point. I personally would stock up on food first before gold or silver. Having said that, even in primitive markets, gold and silver has been used as coinage for goods. I just wanted to put out the most widely accepted theories.
I agree that greed destroys. What a pity with so many greedy people around.
If by hit the fan you mean the entire market system of the world crumbles and we are all living by our wits alone, then paper money will be useful for fire. You sound like someone I would like to know in the event the world turns upside down. You must know how to fish and hunt. I fish, but don't hunt. I figure I could learn fast.
Thanks for your thoughts.
True Cures from Payette Idaho on August 07, 2011:
I usually ruffle a lot of feathers when I suggest this but isn't it more practical to put value on paper money instead of metal money.
I also get a little confused as to why someone would want gold or silver if the stuff really hits the fan. You can't eat gold or silver, far as I know you can't burn it for heat where you can start a fire with paper money.
I'm assuming the value of gold is only related to the market and the value we can be convinced to put on it. When there is no electricity or fuels, if it ever happened I would think beans would be more valuable than gold.
Clearly it is all economics which is important when food is plentiful. But for me and my life it is important that people know that nothing is as it seems. It seems gold is really important, but it's not unless people are convinced it is.
It's all very sneaky and the love of money is the root of all evil. Is gold the purest definition of money or is it spice or is it paper?
In the 50's John, the fishing and hunting was much better. The 50's and 60's where the good old days I often hear about and never experienced.
Pat on June 20, 2011:
The People's Bank of China (PBOC), the central bank, announced today that it will issue more gold and silver commemorative coins featuring the giant pandas to meet soaring demands for precious metals!
john000 on June 15, 2011:
Thanks for the comment.
Silver certificates have some numismatic value. I don't know whether it holds for all of them, or whether just certain ones, but for a generation or two they are an oddity.
Growing up in the 50's and 60's I did not appreciate a lot of things. On reflection, some of the tried and true ways were not so bad, like having your money convertible!
MobyWho from Burlington VT on June 15, 2011:
Good timing! Just yesterday I took several saved "Silver Certificates" to my bank, asking for silver dollars. They could not produce them, nor would they try. Those were used ones. I also have ten uncirculated notes in sequence. Maybe I should frame them and add some sarcastic comment or cartoon?
viveresperando from A Place Where Nothing Is Real on May 09, 2011:
chamilj from Sri Lanka on May 09, 2011:
I think people's trust in paper money is going down.