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The Money Supply

Why Should We Care about the Money Supply?
Of all the things we should understand in the financial world, the one that affects us most is the money supply and how it is managed. They who control the money supply control the world.

Where Does Money Come From?
Believe it or not, thin air. That’s right, the American government (or any other government for that matter) can create money at any time, and many do. Some governments may choose to “back” their currency (money) with tangible assets such as gold others do not.

Types of Monetary Systems
There are two basic types of monetary systems: those managed by fiat or by a representative money system. A fiat system is a “full trust” system. In a fiat system, the government creates money by its sovereign hand at will for whatever reason it sees fit. In a representative money system, the currency is tied to the value of some type of relatively scarce “high-value” asset such as gold. At first glance it would seem that the latter would be the better policy – at least its not thin air! But in practice it turns out that a representative money system may actually be less desirable because it is relatively easy to control the price of a scarce commodity and therefore by design or by accident, the monetary system may be adversely affected more easily. Because of this, representative money systems may be more open to corruption. On the other hand, governments of the world don’t have a very honest track record on sound monetary policy (talk about corruption!). So a representative money system is really the way to go. It turns out; economies are only as good as the people’s trust in them anyway. But the world has abandoned representative money systems so we are left with fiat systems as the current type of monetary system. The USA has a fiat monetary system.

The Value Of Currency
What is a dollar worth? Well, a dollar. Not satisfied with that answer? Good for you. Typically we are not concerned so much with the value of a currency as long as it serves its purpose as a medium of exchange. It is the things money can buy that are of value, not necessarily the legal tender itself (although it would be better if money had value). But today it really has no intrinsic value other than its use. If producers accept a currency for a negotiated price of an item being purchased and don’t try to change the price, and if it more or less holds its value over time then a currency has served its purpose. On the other hand when suppliers demand more currency (higher prices) over an extraordinary short time span (say daily), then that is a good indication that a monetary system is failing indicated by a currency losing its value.

We can measure the
relative value of a currency by comparing it with other currencies. When we travel, we often have to exchange our dollars for a foreign currency at the given exchange rate. These values fluctuate. This fluctuation is the market’s way of telling you how well your government is managing your currency. When the exchange rate of the dollar falls consistently, it is a good indication that your government is up to no good again – printing money for no good reason. This is a strong argument for having different currencies for each nation – it keeps them more honest!

Currency Distribution
So how does this all work? It’s all about trust. And a little bit of fear as well. Suppose we were to start over with the money supply. How would we do it? Someone we trust (a democratic government) would gather together all the producers and distribute to each of them an amount of cash for whatever they produced based on some (perhaps arbitrary, better relative) value. Say one farmer had ten chickens and a manufacturer had ten cars. The farmer would be allocated as much cash relative to whatever the value of chickens was and the same for the car company and everybody else who produced something of value. This would occur one time, although it could occur as needed if things get too much out of whack. It shouldn’t occur very often, because if it did, each new dollar printed would lessen the value of the existing dollars already in circulation. What would happen next? Think about it for a while.

The chicken provider would offer his chickens for sale. He knows there is money out there to buy his chickens because everyone was allocated currency for what they produced. He has faith in the monetary system even though it is backed by a mere promise (well also a few hundred thousand soldiers, perhaps a nuclear arsenal as well, but hey, who’s counting, right?). He would take some of his ten dollars and invest it in producing more chickens. Some of it he would save and some he would spend. Every time he spends on other goods, someone else benefits in the same manner he did.
His actions boost consumption. The currency circulates throughout the economy and everyone begins producing things of value and selling them so they can get currency so they can eat. As producers produce higher volumes, they hire people to help them. These laborers are paid cash and they spend money as well. The cycle repeats itself and all of a sudden we have a thriving economy!

It’s all About Trust
Wow, that was simple. Seems like it might be easy to scam the system. Perhaps, but if the system fails, the society fails. For example with a corrupt government where the people do not trust the government, this doesn’t work very well and we get high levels of inflation and ultimately a government collapse. In other words, if the government floods the market with currency for no good reason, the value of the currency falls (because it was printed out of thin air again for no good reason). Since there are more say dollars in circulation, producers must raise the price of their goods since it now takes more currency to buy and produce the same thing and surprise! We have inflation.

Anyone for a Common Global Currency?
Wouldn’t it be more efficient to have one currency? Perhaps, but can we really trust only one monetary authority? Turns out that to hand the privilege and control of printing money to a single large centralized authority is very dangerous. To whom are they accountable? Even if they start out with honorable intentions, how long will that last given what we know of human nature? History is rife with examples of how people are very, very easily corruptible. Having each nation control its own currency is actually a safeguard against global instability and corruption! [Note to self: The world is actually moving in the opposite direction – see European Union]

Lend Me The Money
Okay, we know that the government just printed up the money, but we can all see that this system works, so we don’t have any problem with it. In fact, we rather like it. So let’s not mess with it, okay? But what if we want to borrow money? In the current system, we would have to rely on the existing currency in circulation. We would have to ask those who had saved up cash if they would be willing to lend their deposits, risking it in return for interest. These lenders would likely require collateral, but none of this requires additional currency. Others who had saved their cash could offer insurance against loan defaults.

Show Me The Money
Unfortunately, some clown noticed that when people put their money in the bank, only a fraction of it is actually demanded back (withdrawn) at any given point in time. So why leave all that cash just sitting there when we can make use of it? Let’s allow the banks to go ahead and lend out “just a portion” of the people’s money. Now we don’t even have to ask permission of the person who deposited the money as savings! We can allow private banks to make a profit on it in return for “managing” it. Oh and by the way, that “portion” we will allow to be lent out will be say 90%. As long as less than 10% of the people demand their deposits at the same time (thereby making a “run” on the bank), all will be just peachy. We’ll call this a fractional reserve system. Show you the money? Well I can show you 10% of it. But the rest will be “guaranteed” by the folks with the guns. Sounds like one big giant Ponzi scheme, eh? Well, it is. But as long as everyone sits idly by and allows it to happen, who’s complaining?

Enter the Economic Collapse of 2008
If a 90% vacancy rate makes you nervous how about a 100% rate? That’s right – banks becoming so leveraged that there are actually no cash reserves to cover withdrawal demands. What about making loans with “teaser” rates that allow people to “qualify” for loans they can never repay? Why would a bank do this? Because the brokers get fees & commissions every time they churn a loan. This is the result of “privatizing” banking. Normally, who cares? In the free market, people make bad decisions and they pay the consequences. Unfortunately when the entire banking system is private, including the Federal Reserve, we ALL pay for such shenanigans.

What happened to the Gold Standard?
Wasn’t the US dollar
backed by gold at one time? Yes it was! Back then it was easy to see when the government was printing money (counterfeiting, causing inflation) – the value of the dollar would fall against the price of gold. But your “public servants” didn’t like the accountability implied by that arrangement – so they changed it!

Why does the Federal Reserve Print Money?
We are told that manipulating the money supply is a necessary tool for the Fed to “control the economy” and to “even out the natural business cycles”. The truth is that this is completely unnecessary and actually harmful. All printing money does is create inflation.

Who Do You Trust More?
So we have to trust someone in a market economy backed by a fiat monetary system (like the USA). Unfortunately, the choices here aren’t very good. You can trust either your government or you can trust the private sector. American politicians have chosen to do both – to trust just one private bank, which is clearly the worse choice of all. But it hasn’t always been this way. In fact Abe Lincoln printed “greenbacks” when it was clear the banking system had become corrupt. Andrew Jackson was another heroic American president who saw the dangers of either one or a small number of privileged private banking institutions. Oligopolies of private banks are dangerous because they are private - they have no obligation (like a government does) of accountability toward the electorate and they collude against the electorate for their own profit. The next less-worse choice is a government, at least in a democracy. Although the government of all nations are corrupt, some are less corrupt than others and at least there’s a chance there may be an occasional public servant in such a system, even if only for a season.

Is That The Best We’ve Got?
So we’ve got a giant ponzi scheme that has gone bankrupt managed by self-interested liars. There has to be a better way. Turns out there is, see the Banking proposal on this website.