By the dictionary definition of fiat money, that’s what we have in just about every country of the world. Classic economics lore teaches that fiat money usually leads to hyperinflation and financial chaos, yet the currencies of Europe, Britain, Canada, and a few other countries manage to retain their value reasonably well. Are these currencies considered fiat money? Or are they considered to be backed in some definite way that leads, perhaps, ultimately to the productiveness of the the economies involved?
Well…until pretty recently the US (and most nations) used representative money as opposed to fiat money. Said another way US currency was pegged to the gold standard. Indeed, if you can find old enough money printed right on the bill it said that the bearer was entitled to the face amount of the bill in gold. It wasn’t till 1971 that Nixon removed the US from the gold standard.
Today US currency can be considered fiat money but it has value based upon the credit worthiness of the US government. As long as the US resists printing money willy-nilly the dollar retains its value. Global currency trading markets also exist to adjust the relative value of currencies on a running basis. Indeed, the gold standard couldn’t reasonably have been expected to keep up with the US economy. There isn’t enought gold around to back a currency based on it that could reflect the economic power of the US.
What classic economics lore is this? I’m generally a follower of the ol’ classical dichotomy, myself. Monetary neutrality, and all that. The basic idea is that money is nothing but a place holder for goods and services, and it doesn’t matter if it’s backed by gold or silver or toenail clippings, so long as people univerally agree that one hour of burger flipping equals about six dollars, which in turn equals a pack of batteries.
The fact that we all generally agree to exchange dollars is predicated, then, on the assumption that a dollar will not wildly fluctuate in what others value it. This assumption is, in turn, based on everything Whack-a-Mole mentioned.
This is all grossly simplified and ignores many valid points on the part of the gold standard crowd. But I think you’ll find most economics PhDs out there agree that there’s nothing catastrophic about fiat money, and point to the U.S. as example #1 
P.S.: it’s a bit over simplified to say “Nixon took us off the gold standard.” If you’re curious, look up the ol’ Bretton Woods system, which is, strictly speaking, what Nixon took us out of.
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How many US dollars are in circulation?
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I know the mint constantly replaces money, but minus the money that is destroyed each year, do they increase the circulation often? By occaisional acts of congress, or it there a formula?
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Is all the money that is traded electronicly representing physical paper money somewhere? If not, how does that work.
My head hurts.
The vast majority of the money supply is not represented by bills or coinage. The assets of banks and large financial institutions doesn’t exist in paper form.
Think about your local bank. You deposit $1000 in cash and they give you a passbook that shows that amount. They in turn lend that money to your neighbor in the form of a line of credit, which she uses to buy some equipment for her business. That money goes to the equipment manufacturer who deposits in his account and it gets lent out again.
Here’s a somewhat decent link to get you started: http://www.udel.edu/htr/Psc105/Texts/macro.html
I had a pretty lengthy response to drhess, but it got eaten. The short answers are:
1.) About 646.6 billion dollars.
2.) Fun Facts from the Bureau of Engraving and Printing:
http://www.moneyfactory.com/document.cfm/18/106
I believe the amount of money the BEP is allowed to print is set by the Federal Reserve, and they generally want as nice, steady, predictable money supply.
3.) Nope. The Federal Reserve ( http://www.federalreserve.gov ) probably has a good answer to this somewhere, but I haven’t found it yet. But “M1” is generally considered the true supply of money, and it includes all da currency plus highly liquid accounts such as checking accounts.
Also, if you’re head is hurting, it means you’re doing it right 
Definitely not. You just need as much paper (or metal) money as needed for transactions actually made with banknotes or coins (well…plus some stockpiles in banks and central banks or under mattresses).
Most of the existing money only exists in its electronical (or before that written) form. It’s written somewhere that you have XXXX dollars deposited in bank X. But you won’t find these dollars anywhere in the bank. Banks are only required to have a given (and low) %age of their deposits in actual, physical money.
When a bank lend you some money, it doesn’t have it in physical form, either. It just write somewhere : “from now on, there is XXXX dollars on the account of Mr Drhess”. When you buy something with this money using a check or a card, the bank just write “there’s only XXX dollars left on the account of Mr Drhess” and “there now XXX more dollars on the account of Mr Drhess’ grocer”. There are no actual bills or coins involved in the process at any point.
Not only that, but a bank will plainly create money by lending more than what is deposited on the bank accounts of its clients.
Printed and minted money is only a tiny part of the money actually existing and circulating. And money isn’t only created by the central banks.
To elaborate a bit on Telemark’s statement, banks are essentially create money through lending (the monetary effect on the community is greater than the amount on the books/in savings) This “money” is backed by the Federal Reserve, which makes it “good money” because it’s guaranteed by government bonds. These government bonds are legitimate, because they’re backed by the Federal Reserve.
What is that called, the ratio of physical money to total money? I only remember bits and pieces of my macroeconomics class.
Here’s a link describing how the percentage is arrived at (determined in 1989): Bank Capital Requirements
This is why it is such a problem when there is a run on the banks as happened during the Great Depression. Banks were failing and people became worried that they would lose all their money so they ran to the banks and withdrew what was in there. A vicious cycle started…the more people withdrew the more unstable the bank became and the more failed so more people went to withdraw their money. Financial collapse.
If you look closely at your bank’s policies they can deny you access to your money for several days if they wish to avoid this very problem. In practice they don’t and will hand over all your money when you ask for it but if you were a sufficiently large depositer with (say) $1 billion in the bank I bet they would invoke their priviledge to keep that money from disappearing overnight (and don’t bother telling me it’d be silly to keep $1 billion in a single institution…it’s just an example).
To be perfectly accurate, banks don’t “create money” by taking deposits and lending them out. With every new dollar they lend to someone, they also take a note for a dollar, plus they mandate interest payments. However, they do create enormous liquidity of existing dollars.
The only place money is created is when someone takes some money and builds something which is valuable enough that someone else will pay more money for it. That and when the government prints it of course, but that’s minimal in the scope of things.
Are you sure there is a 1:1 ratio of money taken in and money lent out? I thought banks could lend more than they strictly had in deposits although they are definitley linked. My earlier link seems to suggest the bank has to maintain a specific ratio of despoits to loans but the loans look like they can exceed deposits.
You may find this of interest: http://landru.i-link-2.net/monques/newmonsys.html
Wrong. Fractional reserves very much allow the creation of money and there is certainly not a one to one relationship.
However, creating new money, as we see below, does not necessarily do anything at all for actual wealth, the stock of valuable things.
Wrong, you’re confusing wealth with money. Money is just a place holder, new wealth, or value, is what you refer to here.
In any case, the general idea then is both the government (directly and through indirect means via the banking system) and banks (in a more limited fashion can create “money” which is just a numerator – the stock of wealth or real value remains the same if the stock of dollars, e.g., increases w/o an increase in the stock of wealth, but the number of dollars per real unit of wealth increases.
Fascinating. I think the author should call his system the “MoneyCube.”
Only if you pay me first.
Ok, now, it can all be summarised in one simple phrase: A fool and his money are soon parted.
One thing that must be remembered, in the modern era, money has no physical existence. Those coins and bits of paper that get shuffled around are not money. They are merely tokens that represent money. The “real” money is merely a social convention.
Nice linky.
I’m surprised nobody has yet mentioned the three money aggregates that are currently mesured: M1, M2 and M3.
Here’s a great site. In fact, you could spend all day there.
MONEY: WHAT IT IS - HOW IT WORKS
Whack-a-Mole wrote
They can’t lend more than they have in deposits, but they can have money which is redeposited several times. Say you put $1,000 in the bank and they loan me $900. So they have $1,000+$900 = $1,900 in deposits, from an original $1,000 deposit. The only issue (and this was my point) is that in addition to those $1,900 in deposits, they also have a loan owed to them for $900(+interest). So the additional $900 isn’t really money that’s been created, as for each dollar reintroduced into the system, there was a coresponding $1 debt created as well.
Let’s imagine a world with no banks. What would someone with an extra $1,000 do? Perhaps they’d loan $900 of it to someone else and keep $100 on hand to be safe. So, even without banks, that same money+debt (=0) is created, it’s just that the banks make the process so much easier, as a broker between borrowers and lenders, and as a reputable middleman.