Currency v Money

Posted | 14/11/2014 / Views | 3034
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We’ve had a couple of emails asking about yesterday’s graph (thanks for your questions btw, they are welcome anytime!).  The following is from our last seminar and it describes how ‘money’ is now created (using the US as an example but applies to all fiat currencies).

  • Money was backed by gold until 1971 – “The Gold Standard”
  • All “money” now is created by debt and is backed by a “promise”
  • How is it created?  USA example:
    • Government (Treasury) sells debt (Treasuries / Bonds) to raise funds for continual deficits
    • Buyers get paid interest (yield) and then paid back on maturity
    • The “Fed” (US central bank) buys Treasuries from member banks
    • It “pays” for them by simply crediting the banks - “printing money” by a keystroke
      • Banks then multiply that by around 10 times (“Fractional Reserve Banking”)
    • The more the Fed buys, the less available, increasing the price
    • The higher the price the lower the yield.  Lower yield = 
      • Lower interest rates for you and the Government to borrow
      • Higher yielding investments look more attractive 
    • But all these bonds purchases sit on the Fed’s balance sheet and need to be paid back!

That’s why you’ll hear people say gold and silver are money, not the bank notes in your wallet.  A fundamental requirement of ‘money’ is it must have intrinsic value.  Gold and silver have that by virtue of how rare they are and how hard they are to produce.  Paper currency is only an easily produced government promise… the paper itself is worth nothing.