Where Money Comes From, Part 3

This is the third and final blog in the series regarding where money comes from. I will be talking about the possible futures of the Federal Reserve, money, and our entire monetary system. In the previous blogs, I talked about where money is created and how, a brief history of the Federal reserve (the Fed), what the Fed does and how it has not fulfilled its mission. I also teased the best and worst case scenario’s for dealing with the Fed in the future.

There are very few people who think that the Fed is going away anytime soon. So what can we do with the Fed to ensure that does a better job of fulfilling its goals of stabilizing the economy, maximum employment rates and stabilize prices? While I believe we would be better off without it, there can be a world with the Fed still in it. It would have to begin with a massive audit to root out corruption and identify just how monetary policy is set. From there create hard and fast, publicly available rules governing what the Fed can do based on how the economy is doing. For instance, if the economy changes by x amount in a particular sector, there is a preset action that the fed must take that anyone with an interest can read about beforehand in the rules of monetary policy. No surprises, no whims of fancy that may benefit friends while hurting everyone else. Having predictable rules would reduce some of the panic for investors.

Another action that could be taken without getting rid of the Fed entirely would be to untie the world’s currency to the US dollar. This would create competing currency throughout the world. When currencies are not tied to each other, there could be several different types of currency to choose from when doing business. Many countries might tie their currency to what they produce like sugar or wheat, or oil. Some might be backed by gold and silver, other could be “fiat” currency, meaning not backed by anything at all, (which is what we have now). Some countries might elect to keep their national banks and others may go to a private banking system. The beauty of this system would be that competition would keep each system honest. If someone doesn’t like one countries monetary system, they could easily move their money to another. This makes bad monetary decisions more painful and therefore less abundant. This type of system could work with or without the Fed, so in my opinion, which is worth exactly what you are paying for it, is the most likely option for the future.

What would it be like if a miracle happened and the Fed gets abolished? Looting? Anarchy in the streets? Mass murder over the price of Twinkies? No. We might be inconvenienced by having more currency options, but we are already used to this, kind of, in the form of gift cards. When you get a Wal-Mart gift card, what you essentially have is currency that can only be used at Wal-Mart, basically Wal-Mart bucks. That gift card is exchanged for US dollars at the cash register. Each bank might be able to issue its own currency. So maybe instead of that gift card being backed by Federal Reserve Notes, it’s now backed by Bank of ‘Murica bucks, or Citibucks. An exchange rate system would probably be set up privately to see how the value of each currency compares to the other. You would still use your debit card and the store would decide which currency it takes. Your bank would automatically account for the exchange rates behind the scenes. This is not a new system, we actually had something like this before the Fed was put in place. This is not as convenient as having only one type of money, but it would make it much harder for the government to accumulate massive amounts of debt.

In the olden days, you could bring your dollar to any bank and exchange it for the corresponding amount of gold stated on the front of the bill. From the consumer’s perspective the only difference in non-Fed money would be what backs that dollar. Wal-Mart bucks would be backed by ill-fitting jeans and bicycles, McDonalds bucks would be backed by hamburgers. The business would then decide how to exchange the money we give them into currency to buy more stuff to sell. May the best money win. I can’t imagine that Visa or MasterCard would make our lives that much more difficult by only being good in one currency. They would probably want to stay in just as many retail outlets as they are now so would work it out with whatever currency becomes available. The world would keep on truckin’, normal people would keep on buyin’.

This series was in no way meant to be an in depth look at our money system. It was meant to be a very shallow overview of how things work, and what could be done to make them work better for us and our future generations. This is true partly because very few people have an actual in depth knowledge of how things work, I definitely don’t, and also it would just take way too long to write. I recommend using this information as a jumping off point to learn more about our money and banking system. I know it’s boring, but you might just be doing yourself a favor in the end. Happy New Year everyone!


Where Money Comes From, part 2

Last week, I talked about where money comes from (thin air), and a little about how our money is a physical representation of our debt. This week I want to talk about why and how this came to be. I will go over a brief history of the Federal Reserve (the Fed), with a few highlights. I will try to show how having a national banking system might influence monetary decisions made by congress and some of the advantages and disadvantages of having the Fed.

The Fed was signed into law today 100 years ago, December 23, 1913 by President Franklin Roosevelt. It was not the first attempt at a national bank, there were a few before it, never lasting long. People were afraid to put that much power in the hands of bankers. The currency back then was loosely backed by gold and silver, at one point before central banking local banks used to issue their own currency representing the gold in its reserves. During bad years there would be times where everyone would want to take their money out causing widespread panic and recession. The reasoning behind the Fed was to standardize the banking industry and try to make the economy smoother and more predictable.

What actually happened was that no one really had a good idea of the policies needed to effectively run an economy. Congress was given a blank check do whatever they wanted. The central bank made it much easier for the world to do things like go to war because of the blank check given to it by the Fed. By sheer coincidence, it was decided that an income tax was needed to support this new governmental power of the checkbook, so also in 1913 the 16th amendment was passed. This is the amendment giving congress the power to collect income taxes on individuals and corporations.

After WW1, the Fed basically stopped using gold as the standard for monetary policy and started selling the debt from the government called government bonds to banks on the open market. This was called “open market operations”, and was used all during the 1920’s to keep the economy rolling, until it crashed in 1929. The great depression was cause directly from the fiscal policies of the Fed, not by crazy unregulated Wall Street and banking industry like they teach you at school. The policies of Fed caused the great depression, and made it worse, and the policies of the government made it much worse. Probably what happened is that the people running the Fed did not really have a good idea of how to fix things, so what they did compounded the problems.

The first major reform as a result of the great depression was the Glass-Steagall act. This separated commercial banks and investment banks. It also created the FDIC, and made the Fed in charge of making sure that open market holding companies were adhering to the standards set by the act. Also President Roosevelt made it illegal to own gold and silver and banks getting loans from the Fed had to use government securities as collateral. This action was the second time that we were taken off the gold standard and was designed to be temporary. In 1933 congress passed the gold reserve act, fixing the price of gold and making it attractive for foreign countries to trade gold for American dollars so they could use dollars to pay off their war debt. America amassed a massive amount of gold because of this and most of our money was being kept overseas.

After WWII, the Fed’s monetary policy was creating a problem for the rest of the world so the old monetary system was scrapped and a new monetary system was created called Bretton Woods system. This basically made the US dollar the standard currency that every other countries currency was based on. The US dollar was still indirectly based on the gold standard, but the rest of the world was on the US dollar standard. This didn’t last long, and less than 30 years later they were scrambling for the 3rd monetary system for the world.

In 1971 under President Nixon, we went off the gold standard officially and completely. The US dollar was now called a “fiat currency”. This means it is not backed by anything other than the power of the government. It also means the Fed could start expanding the money supply at their leisure. Up to that point the money supply grew at an overall even way, but now all bets were off. In 1959 there was 300 billion dollars in circulation, by 2006 it had climbed to almost 12 trillion. In the 100 years since the Fed was instituted, the dollar has lost 95% of its value.

Eventually, like all fiat currencies, the dollar will fail. We are starting to see the signs all over the world. Russia’s currency is on the verge of collapse, many European countries are close to collapse and the American dollar is close to collapse. In short, there is very little or no evidence that having the Fed has improved our economic situation at all. At the same time, no one can say we would be better without ever starting the Fed, but in comparing the goals of the Fed to the outcomes in those areas, they have failed to live up the their promise. At best we need to have the power to do a full audit on the Fed at scheduled intervals, at worst we should scrap the whole system and start over. It probably wouldn’t be as scary as it sounds.

Where Money Comes From, Part 1

I decided to use the holiday season while news is slow and people are out spending money to write a little bit about our money and where it comes from. I will be talking mainly about the Federal Reserve, what it does, how it interacts with the government and why it is important for people to know something about it. This is not a fun topic. I do my best to write in a way that people who don’t really pay attention to politics can understand and enjoy. This is going to be a stiff test, so I ask that if you are one of those people to try and stick it out. I am not an expert in any way on anything I talk about, (so far). I am not an economist or a political scientist but I do, however, enjoy learning things and understanding how the world we live in works, so I write this blog as a way to organize my thoughts. This topic is going to take more than one blog, so I think I will break it up into a few parts.

Where does money come from? It’s not something most people think about much. Money comes from the government right? They print the money we use. Well actually, not really. There are a few main players in this game, so let’s meet them. First you have the congress, it’s their job to spend the money that our government uses to pay for stuff. There is the treasury department, which is in charge of printing the physical money, and you have the Federal Reserve, which is like our national bank.

The congress votes to spend money on stuff like roads, war or whatever. The only problem is that they don’t have any money in the government, they have to get some from somewhere else. What they do is have the treasury department print a piece of paper called a treasury bond, which is basically an IOU that says if you give me money so I can buy stuff, I’ll pay you back later with interest. Banks buy these bonds and take them to sell to the Federal Reserve, who writes them a check to buy the bonds. The checking account that they write this check from has no money in it. They give this check to the bank that bought the Treasury bond and presto, money is created. To recap the government traded an IOU from the Treasury department for an IOU from the Federal Reserve and money is created out of thin air.

This money is deposited into a bank where it is spent on whatever the congress voted to spend it on. It is used to pay government employee salaries, contractors doing work for the government and other people. These workers in turn deposit the money into their personal banks. Let’s follow government employee “Joe” for a minute. He gets his paycheck of $1000 deposited into his bank account. What he is actually doing is loaning his paycheck to the bank. The bank then puts $100 of that paycheck aside for Joe and lends the other $900 out to other people. This doesn’t mean that Joe only has $100 in the bank. What happens is that the bank just creates $900 more dollars out of thin air to make sure Joe doesn’t freak out while they give his original $900 away to people who need a loan. This is called fractional reserve banking. It means that the bank only has to keep a fraction of the deposited cash on hand at any given time. The percentage can vary, but 10% is normal. Joe’s $1000 deposit immediately becomes $1900. When the person that took out the loan for the $900 puts the money into their bank, the bank deposits $900, keeps $90 safe and lends out the remaining $810. Now Joe’s $1000 has been increased to $2710. This goes on and on until the original $1000 becomes $10,000. Fun fact: 97% of all money is virtual. Just numbers on a computer screen. To recap, congress trades an IOU for an IOU from the Federal Reserve and money is created, People deposit that money into banks where they just magically add 90% more money into the system.

People who have jobs work for money. This money generally comes from someone who got a loan from a bank who gave them someone else’s money, then replaced that money with new money. The guy who got a loan to start a business uses some of that money to pay an employee. This is where our money comes from. We then, in turn, pay taxes to send some of that money back to congress so they can pay for more stuff. Congress then has to use some of the tax money to pay interest on the IOU that got sold to the Federal Reserve. This all happens on a massive scale. To recap, congress trades an IOU created out of thin air for an IOU from the Federal Reserve created out of thin air, to give to people to put into banks where 90% more money is created out of thin air and lives on a computer screen in a bank. This money is lent out so people can start businesses and pay people with this money created out of thin air in order to collect taxes to pay interest on money created out of thin air by the Federal Reserve. Clear? Good.

What this really means is that every single dollar in existence is debt. If you had to borrow the first dollar, how do you pay that back? You have to borrow more dollars to pay back the first one. And so on, and so on. Every dollar in your bank account is owed to someone else, by someone else. If there was no debt, there would be no money. This is how money is created in virtually every country on earth, throughout history. Of course it is not sustainable and will eventually crash, just like every other time in history. This seems like a good place to stop. I will continue to explore this topic further next week. Don’t forget to buy that thing for that person you forgot about.

PS. Look at a dollar bill, or the one in the picture above. What does it say at the very top? It’s not money, it’s a Federal Reserve Note.

Having Your Cake, and Eating It Too

I struggled a little this week to find a topic of discussion. I’ve been too busy with holiday parties, Christmas stuff and life in general. I decided to go back to a theme that has been quietly and not so quietly present in most of my blogs, and deserves a proper mention. When you ask most democrats what the difference is between a republican and a democrat, or a conservative and a liberal, you will hear things like, democrats for common people and republicans are for rich people. Conservatives are against gay people, women and minorities, liberals like to help people. A typical republican answer might be that republicans like lower taxes and democrats like high taxes. Conservatives are moral and liberals are hedonistic socialists. The actual differences lie in the size of government that each party and group prefer. Republicans tend to like a less powerful central government where states have more power and democrats prefer a large central government that treats everyone the same. While what actually happens while each party is actually in power is very similar, I’m going to take the under riding principles at their word and speak to those people who think our federal government’s job should be to help people. I’m not sure if there is an actual term for these people. Libertarians call them statists. Being called a “statist”, by a libertarian can be done in a few different ways. Adjective- “Stop being a statist idiot!” Noun- “Stop being a statist idiot! You statist!” It’s basically not good.

The problem with these statist type of people is that they want to have their cake, an all-powerful and giving government taking from the rich to feed the poor, but they don’t want that government to interfere with their lives, eating the cake. What these people apparently don’t get is that when you cede all that power to a central government, you basically hand them your freedom to take care of as well. For instance, if you were to eat to the point of being bed ridden and asked a nurse to take care of you, that nurse gets to pick how they take care of you. It’s really that simple. You can scream for all the Twinkies in the world, but that nurse does not have to give them to you. If you give your government the power to dictate your freedom, security, income, healthcare, housing, food, what you can and cannot buy, sell or own, they have that power, you cease to. There is no case in which you share your freedom once you give it away.

Who cares? We have a benevolent government that concerns itself with helping the less fortunate and it only enhances and protects my freedom. If that were true it would follow that where in the country we have the largest government there is the most freedom. Is this so? Certainly the freest parts of the country would be the poor inner cities with all the public housing, public transportation and large police presence right? No? Certainly, then, the safest people in America live where the government protects them with rigorous gun laws and highly regulated businesses, right? The truth is that where you find a large governmental presence, you find the most oppressed people. Where you find the people most helped by government, you find the people who are least able to help themselves.

Our government, while better than most, is not immune to power. There are two sides to every coin. If you want a government that enforces you freedom, expect some enforcement. They are able to make the rules because they have the biggest guns. You want your government to make people to behave a certain way, expect that other people will want the government to make you behave a certain way. You want your government to take from some to give to others, expect that you will have something taken from you. If you live your life completely dependent on government, understand that they own you and can do with you what they wish. There is no such thing as something for nothing where our government is concerned. Every time a law is passed, you give up a little of your freedom. What’s worse, you give up a little of my freedom. Stop it.

Ferguson, Not Ferguson

In the aftermath of the riots in Ferguson, MO last week, I decided to write this week’s blog about a very small part of what is a very complex issue in race relations in America. I have seen a lot of posts from my black friends on Facebook decrying the behavior of the police toward the protesters, rioters, and black people in general, not only in Ferguson, but in the whole country. I have seen just as many if not more of my white friends post things in favor of the police and the actions they have taken to protect themselves and the town. In the interest of full disclosure, I am a typical middle aged white guy. In the vast majority of cases I am pro-law enforcement. I live in the suburbs, so I have had a very positive experience with police officers in my life. For these reasons I cannot comment on how black people and especially poor black people get treated by law enforcement as a whole. What I decided to concentrate on is how the government views white people and black people differently and what might be one cause of that. I try to keep my blogs to around 1000 words and trying to fully develop this topic would take thousands of pages, so I’m going to stick to the topic of voting patterns for the purposes of this article.

If an average person were to do nothing but watch the news they would probably be under the assumption that most black people are poor. That is actually not even close. If we round the numbers to make them pretty, about 25% of black people are poor, 65% are middle class and 10% are upper class. In contrast about 10% of white people are poor, 75% are middle class and 15% are upper class. I bring this up because the perception of police are probably varied by income scale to some degree. Rich black people probably have a much different experience with the police than do poor black people and the same could be said for white people. What people need to remember is that a police officer is not the authority. A police officer is a hammer in the toolbox of our elected officials. They get paid to enforce laws passed by other people, whom we elect. Our local, state and federal governments are the authority. There is a certain circular of logic that is taking place in poor areas that goes like this: poor black people have a negative view of the police, the police see this attitude and are more fearful when dealing with these people, causing a quicker than average violent response against them, that causes the poor black people to have a more negative view of the police. This cycle repeats indefinitely.

Here’s the problem, white people among these income brackets do not vote for the same people. Roughly half of white people vote democrat and half vote republican. Black people on the other hand vote 96% democrat regardless of income. I’m sure that those 4% that vote republican are the more wealthy ones, but they are not significant when it comes right down to it. Why does this matter? When politicians are trying to get elected, they spend their money where it will get the most votes. That is to say, they will spend time and money on people who may change their mind and vote for them. Generally, when it comes to political parties there are always 10-20% of the people that will vote right down the party lines no matter who is running. Politicians take these people for granted and court the other 80% to try to take them away from the other guy. The other guy ignores those 10-20% because it would be a waste of money and time to try to get them to vote for him. When you apply this logic to black voters, you begin to see a small part of what is happening. Democrats know that no matter who is running that 96% of all black people, rich or poor will vote for him/her regardless of what they say or do, and will keep voting for them election after election no matter what they have done, simply because they are a democrat running against a republican. Because of this fact two things happen, one, black people are taken for granted by the Democratic Party and two, black people and their concerns are completely ignored by the Republican Party.

Why does this matter? Well, over the years many laws that hurt black people more than white people have been passed by both parties. The democrats passed the welfare bills in the “war on poverty”, which have devastated the black family. The republicans started the “war on drugs”, which has had a much more devastating effect on black people than white people. Polls show that average black people support ideas like school choice and have a negative view of welfare. They have a high percentage of Christian population. These are all conservative republican ideals. You will never see a democrat vote for school choice because it would upset the teachers union, a group they must court to win. Since they don’t have to court black people, the union wins. A democrat will never curb the drug laws because they think, and probably correctly, that white voters would never go for that. They must court white voters, so white people win.

What about power in numbers? There is something to say about power in numbers. Black people do, in fact, have a seat at the Democratic Party table. The problem is that black people are viewed as a voting block instead of a varied group of people, and are as such relegated to the “kids table” if you will. They know that they need to keep you happy, but know that a little cake every once in a while will keep you where you need to be. Black people who stray are not treated kindly, see Clarence Thomas, Ben Carson, Thomas Sowell, Allen West, Herman Cain, etc… While democrats cater to hundreds of special interest groups and break them up into categories like, women, blacks, Latinos, unions, etc…, the republicans work differently and break up categories into broader things like Christians, libertarians, Tea party, etc… The difference is that when a black person asks a republican what they can do for black people the answer is usually that republican polices make it easier for a black person to do for themselves. This is a scary proposition when it comes to reforming welfare, social security and the other entitlement programs.

It is easy to understand why black people would be hesitant about voting for a party that ignores them and perpetuates the war on drugs. It is not so easy to understand why a black person would vote for a democrat, a party that takes them for granted, have kept them by design as a permanent underclass for the last 50 years. A party that was on the wrong side of the civil war, Jim Crow laws, segregation and even the civil rights movement. A party that after all these years of outright racism, has evolved into the more palatable yet equally dangerous benign racism of lowered expectations. Yes, the Republican Party ignores you, but if they believe what you believe, vote for them. Contrary to what democratic leaders tell you, they do not hate you, and they do not want to harm you. If the black people were as varied as white people in the voting booth you can bet that you would not be ignored by either party for very long. Like my grandfather used to say, “If you always do what you always did, you always get what you always got.” He was a wise man.