Yeah, probably not. Depression and deflation are not necessarily synonymous just like expansions and inflation aren’t. Generally it’s true, but it doesn’t have to be.
If the money supply doesn’t reflect economic activity, initially interest rates should rise because of supply and demand. BUT, if that persists, it will hamper that activity and the economy will contract. When that happens, demand also drops and therefore so do interest rates. If no one is doing any business, there’s no demand for money.
Reno Nevada’s post is largely correct, but one big nitpick is needed.
The FRB uses double-entry accounting just like any other bank. The banknotes it creates have a status not unlike the cashier’s checks or traveller’s checks created by commercial banks. Yes, the FRB creates money when it buys bonds or other assets with “electronic money” (account ledger entries), but so do commercial banks, the same way, in their fractional-reserve banking. Commercial banks are regulated of course, but the FRB is also subject to certain rules.
Money does seem to be confusing. On the one hand, we’re taught it’s the real thing – the goal of greed. On the other hand, banks create and destroy it all the time, with electron bursts inside a computer.
Because the U.S. political system is now subverted by the Koch Brothers and others who benefit from voter ignorance, misconceptions about money have escalated recently. Some people seem to think that, since today’s dollar only buys 2% of the gold it did when FRB was created, that workers are only getting 2% of the wages they are entitled to. Though prices are relatively stable today, some pundits insist that “hyperinflation” (never just inflation mind you, “hyperinflation” :dubious: ) is the big worry.
Federal Reserve Notes are not in any way comparable to a cashier’s check.
If a commercial bank issues a cashier’s check, it must be prepared to pay that check with Fed Funds (credits on the books of the Federal Reserve Bank, either directly or through a correspondent bank). When a cashier’s check is presented for payment, the bank must transfer Fed Funds from their account to the account of the bank presenting the check for payment. They cannot just make an entry on their own books and say “we owe you.” They must have Fed Funds on deposit in a settlement account with which to settle the check.
A commercial bank cannot just buy unlimited quantities of notes and issue cashier’s checks to pay for them. And it’s not just because of some restrictive regulation. They must be prepared to have Fed Funds flow out of their accounts to settle the checks.
On the other hand, the Federal Reserve does not need to check to make sure they have enough funds on hand to settle a $20 bill. They can get all the $20 bills they want from the Bureau of Engraving and Printing and exchange them for whatever they deem appropriate. If a bank presents a $20 bill to the Fed for payment, the Fed simply creates a credit of $20 in Fed Funds in the bank’s electronic account. They do not have to worry about where they are going to get those Fed Funds from.
There is a big difference. A cashier’s check has to be paid with a limited resource – Fed Funds on deposit at the Federal Reserve Bank. A $20 bill is paid off by an unlimited resource: The Fed’s ability to create Fed Funds.
It would be a huge difference if the government actually was printing an unlimited amount of money. But they’re not and they never had. The American government has restrained itself to printing the amount of paper money that the general economy needs. So American currency has held its value for decades.
So both gold and American currency have demonstrated they can hold their value over extended periods of time. The advantage currency has over gold is that the supply of it can be expanded as needed.
Yes, that would be a problem if the supply of paper currency was expanded far beyond the need for it. But as I noted, that hasn’t happened. The supply of gold, on the other hand, can’t be expanded at all. So the actual problem of gold as a currency outweighs the potential problem of paper currency.
There actually is some validity to the claim: Let’s trace the process backwards a little bit.
The Fed decides that the economy needs more money. It prefers to do this by buying up treasury debt, although it has occasionally purchased other types of debt.
Let’s say it buys $1 million in T-bills from a bank. It then makes an electronic entry on its books that gives the seller $1 million in credits. The Treasury pays interest on the T-bills (unless interest rates have gone down to 0 or lower). As the new owner of the T-bills, the Fed collects this interest. So the Fed has spent $1 million (in the form of money it just electronically created) and is collecting interest on its investment (because it now owns some T-bills).
At this point, the bank decides it would like a $20 bill. The Fed says “Sure! We’ll deduct $20 from your account balance and send you a $20 bill.” So this $20 bill comes from a payment for T-bills which are paying interest to the Fed.
Where is the interest the Treasury pays coming from? Taxpayers. But do keep in mind that after the Fed covers its expenses (including the dividend payment to its member banks), it returns all of its profits to the Treasury.
Monetary policy can be very complex. So in the simplest case, the fed’s role would be to simply provide the money the economy needs and expand and contract the money supply as needed. But even that’s not that simple because of the fractional reserve banking not to mention the whole issue of the "shadow bank system where the reserve requirements are “fuzzy” shall we say.
Reserve requirements are an issue since the money multiplier theoretically is the inverse of the the reserve ratio. If that didn’t make any sense, I can explain, but you’re starting to get the idea of what I meant by ‘complex’. IOW, the money supply is not only a moving target, but one with stealth technology.
Aside from that, the money supply can be used to artificially stimulate or suppress economic activity. It’s analagous in principle to how fiscal policy is used but the actual mechanics are different (although there is overlap). But even that isn’t simple as we’ve seen since 2008. The Fed has flooded the economy with literally a couple trillion dollars which under other circumstances should have caused Wiemar Republic style inflation. That’s what most people expected. Oops.
I’m sorry if I misled. Brief explanations are always a compromise between explaining essential concepts, and giving full detail. I stand by my explanation. I’d intended to mention that FR banknotes are inscribed “this note is legal tender for all debts, public and private” but obviously forgot that as I was typing.
Since we’re being sticklers let me point out that your conception that Federal Reserve Notes are issued at whim and without collateral is incorrect:
[QUOTE=Federal Reserve Act, as amended 1934]
Any Federal Reserve bank may make application to the local Federal Reserve agent for such amount of the Federal Reserve notes hereinbefore provided for as it may require. Such application shall be accompanied with a tender to the local Federal Reserve agent of collateral in amount equal to the sum of the Federal Reserve notes thus applied for and issued pursuant to such application. The collateral security thus offered shall be notes, drafts, bills of exchange, or acceptances acquired under section 10A, 10B, 13, or 13A of this Act, or bills of exchange endorsed by a member bank of any Federal Reserve district and purchased under the provisions of section 14 of this Act, or bankers’ acceptances purchased under the provisions of said section 14, or gold certificates, or Special Drawing Right certificates, or any obligations which are direct obligations of, or are fully guaranteed as to principal and interest by, the United States or any agency thereof, or assets that Federal Reserve banks may purchase or hold under section 14 of this Act or any other asset of a Federal reserve bank. In no event shall such collateral security be less than the amount of Federal Reserve notes applied for. The Federal Reserve agent shall each day notify the Board of Governors of the Federal Reserve System of all issues and withdrawals of Federal Reserve notes to and by the Federal Reserve bank to which he is accredited. The said Board of Governors of the Federal Reserve System may at any time call upon a Federal Reserve bank for additional security to protect the Federal Reserve notes issued to it. Collateral shall not be required for Federal Reserve notes which are held in the vaults of, or are otherwise held by or on behalf of, Federal Reserve banks. [my underlining]
[/QUOTE]
(Banknotes in FRB vaults need collateral no more than do the blank unissued traveler’s checks in Bank of America’s vaults.)
No. The U.S. Treasury arranges for the printing of FR banknotes, but that’s no more relevant than the question of who prints blank traveller’s checks. If the FRB could create money in your sense, there would have been no discussion about the platinum coin to overcome debt limit.
Since FR paper is backed only by other paper, it can be called “fiat” money, but that is a separate discussion.
The platinum coin is a special loop hole in the law that regulates the Mint which under the treasury. The mint handles coins and the metals are regulated by statute - except platinum it seems. That’s why it was a Platinum coin. If you google it, you’ll see what I mean.
You are confusing the discussion by trying to draw some sort of distinction between paper money and electronic money.
There is no distinction. They are interchangeable except for the convenience factor. The Fed creates money electronically. If a bank wants some paper money instead, they can trade some of their electronic credits for paper money (or vice versa).
The Fed lets the Bureau of Printing and Engraving know how much paper money they are going to need, the Bureau prints it, and sells it to the Fed for the cost of paper and printing. The government does not dictate how much paper currency is in circulation.
And, for the record, nowhere did I say that the Fed gives away money for free on a whim. They always demand something of value in return and in this regard there is no difference between paper and electronic money.
The FRB does also hold several thousand tons of gold as collateral, at 1934 prices. (If this were marked to market there would be a sudden windfall of about a half trillion dollars. Don’t tell the GOP: they’d want this undeserved windfall returned to Job Creators. :smack: )
I don’t think I’m the one confusing the discussion. I try my best here on the SDMB graveyard shift while our professional economists are sleeping. Someone (not you, Alley Dweller) embarrassed himself a few days ago in a financial topic in this forum and may be trying for a repeat performance! )
It’s easy to make mistakes unless it’s information you actually need to know. I was under the impression that the fed was exclusively a public body until fairly recently. Were I still unaware of its true nature, I can’t say it would matter to me. Its not really relevant to how they conduct policy.
And as to that, once you get past the superficial aspect of the FOMC conducting the purchase and sale of securities for the fed balance sheet, I’m more or less ignorant of the actual mechanics. I know a few things like some of their contingency plans like for using money market funds to drain vast amounts of liquidity if it comes to that, the fact that they only deal with member banks and the like, but as a small investor, if things are a little fuzzy, as to how they do their accounting, that’s fine. I need that wetware storage space for other things - at least that’s the story I’m sticking with.
edit: I’m sure we covered the basic ‘this the fed. this their charter’ shit in business school, but that gets flushed after the midterm. Everybody knows that.
The Federal Reserve Bank is holding several thousand tons of gold. But certainly not as collateral. Only about two percent of that gold belongs to the Federal Reserve. The rest belongs to other countries and is just being stored in the Federal Reserve vaults. The Federal Reserve can no more use that gold as collateral than your local bank can use the contents of its safety deposit boxes as collateral.
Cite? You’re correct that much of the gold in U.S. government vaults belongs to other countries, but the FRB holding is, IIRC*, much more than 2%.
ETA - * Let me state that more strongly. Unlike many Dopers, I take proud in factual posts. I examined FRB balance sheet just a moment ago before posting. It showed 11 billion dollars plus in FRB gold assets. At today’s prices that’s in the ballpark of the half-trillion figure I quoted.)
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