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A serious question.

The central government lends money to banks, charging interest. The banks lend money to companies and consumers, charging a higher rate of interest. Companies must have credit in order to buy the natural resources necessary to make goods to sell to the people. The companies pay back the banks. But now they owe the banks more money than before. Fair enough, they've made money, so they can afford to pay it back.

But all the money comes from a central source, notably the Federal Reserve in America. They give out all the cash. Then they expect to get back more than they put out. It seems the only way to maintain this kind of system is through bankruptcy - someone along the way has to give all their money to someone, the central cash distribution agency must write off their loan. The amount of money in the system stays equal to the amount given out.

I realise this question may seem laughably simple to many of you, but I am perplexed. I must assume I'm missing something, as a system like that couldn't exist for any length of time.

Right?

There are two sources of money: labor, natural resources, and efficiency. All wealth comes ultimately from one of these three things. Say you borrow money to buy piece of land. How are you going to pay for it? Well, let's say there are 50 trees on the property. You can chop one of them down, plane it into boards, and sell it as lumber.

Since trees grow back in about 50 years, you can chop down a tree every year and sell the lumber. Thus, you have generated a perpetual source of income.

Now let's say that after a few years, you find ways to make trees grow twice as fast. Now you can chop down two trees a year instead of one, and you can double your income. But that's only the beginning! You can go to all the foresters in your neighborhood and teach them your technique in exchange for a cut of their new profits. They'll pay you a fee because their profit will go up dramatically even after they pay you. You're making money because you're showing them how to use their natural resources more efficiently.

A more low-level answer is that money comes from the energy and intellect. Everything can be broken down to the amount of energy it takes to create it--this represents, in a very basic way, its cost. But the energy cost of a process isn't constant; we can invent items and ideas that reduce the amount of energy it takes to accomplish a given task. Thus, intellect and energy together create wealth.

I like ximenez's writeup above but his (her?) answer, imho, refers to the creation of wealth, not the creation of money.

Wealth is indeed created by increases in productivity and efficiency and of better use of natural resources. Money, however, is created by central banks and by banks in general.

To sum the current fiat money situation we have now in a sentence - "Money is created by issuing debt".
If you understand this, you understand the nature of money.


shokwave: uhuh. currency is another thing altogether. It's the stuff that the government prints (on plastic or paper) that usually has the words "this bill is legal tender for ..."

I'm very confused.

What about credit? Is it true that every bank has every cent in deposit for every cent it gives out as credit, including checks? And what about the credit companies?

And the gold reserves? Didn't the United States go off the gold standard many decades ago?

And when the American government stopped buying gold at $35 dollars an ounce--it's what, $350 an ounce now--what happenned to gold holdings? (Didn't the government sell it?)

And about those banks. As private companies, aren't they like some sort of private government? They issue credit in ways they decide, to whomever they decide.

And the Federal Reserve, it is not a government agency, for all that it seems so, but it is run by the private banks, and they determine its policies.

Further, it doesn't give banks money really, it determines how high the interest rate that the banks must charge everyone who doesn't own a bank, and what the rate is for overnight borrowings. This is how the Fed stops an economic boom when too many workers are beginning to get ahead--must prevent inflation you know; inflation lowers the value of those bank stocks.

Whe I reflected upon this question many years ago, it blew my mind--almost literally: I couldn't find anything behind money.

Fort Knox is empty! It wasn't Goldfinger who emptied it. Why bother keeping gold, if it isn't needed.

Money, what a concept!

Evil is the root of all money. It's a false medium...representative of nothing any more. In the old days, it represented gold, silver, and other shiny rocks. Now, that men would want to kill each other over shiny rocks is disturbing; but visceral and understandable on some animal level. Crows are way into shiny things as well.

Then came paper money. Easier to carry...in theory, you could go to that central bank or the king's hoard or whatever and trade the note in for the actual shiny rocks. You no longer can do that...try knocking on Fort Knox's door and asking for a dollar's worth of silver. They'd laugh you out of town, or shoot you.

So we've put our faith in worthless paper...so much faith, that we actually murder each other over it like we used to for the shiny rocks, the valuable guts of the earth itself. Rare, beautiful, lustful...now all's we got is grubby wrinkled paper--spawn of evil--that, at its best, smells like laundry detergent.

Well, there's money and then there's currency (the actual bills). Money can be created from the sources listed above, it doesn't require any intervention by the government.

If I dig up a fabulous diamond and you want it, you could borrow money from a bank (using the diamond you're going to buy as collateral) and buy the diamond from me. By doing this, we've just created money. The economy is a little larger. The bank doesn't have to actually have all the money it lends, just a certain percentage of it.

Currency is different. The government issues currency and none exists without their consent. Currency really doesn't matter, though, it's money that counts. Interestingly, there isn't all that much currency issued at any given time. Think about it: you may have a thousand bucks in the bank, but only a five and two ones in your wallet.

You miss several links that are essential to maintaining monetary balance, Zen baby. Banks give money to companies and consumers....but the reverese is also true. Most of the money banks give out for loans are from deposits made by people or organizations. With enough capitol, which most banks have, they can lend out huge amounts of money, only borrowing from the Fed when they are near the reserve ratio which is the minimum amount of their money they have to keep onhand incase there is a mass withdrawal a la the Great Depression.

The Fed also spreads money through buying or selling of stocks (the first to increase the supply of $ the second to lessen the supply). Also I don't know where you got the idea that the Fed is trying to get more money that they put out. They attempt to maintain economic balance, sometimes increasing the money supply to spur growth, other times lessening to retard inflation.

I think your confusion rests on two main points. First, money has no inherant value. It is only worth as much as we, or more accurately the economy, decide it is. The Fed simply makes this money. The more of it there is, the less its worth if the economy remains stable. This is the nature of currency; gold has no real use but was for a long time the basis of trading.

Second, as I said, money for loans can usually be traced to deposits rather than Fed loans. The moneyis basically recycled over and over, thus creating an illusion of more than actually exists. A dollar can simultaneously be in a bank account, loaned to a company and a check to an employee.

First of all, I would like to declare my love for money, my ambition to collect as much money as possible, and my intent to use that money for my own often benevolent purposes.

Now that I got that out of the way....

Money? Money gets me goods and services. The system I live in accepts green paper as legal tender, since it was supposedly backed by gold by the Feds. No longer, but I don't care. Since I can obtain desirable goods and services with these little pieces of paper (a new computer would be nice), I desire to have as much of it as possible. Makes sense, right?

Do I care if it's a mere representation? The Chinese used stamped rocks with holes in the middle. Micronesian islanders used huge stone wheels. Americans use green slips of paper. Cavemen used rocks. Sure, we can all go back to a barter system. It might be annoying as hell, but it would work. Maybe then the fairness of the world would be fulfilled. I doubt it, but some people seem to think so.

Look. Wildly exaggerating the lust for wealth as a criticism of capitalism is completely meaningless. Money is there. It gets you stuff. Go make some money. Who cares where it comes from.

Incidentally, money existed even in forms of government that approached pure socialism. In North Korea before the 90's, China in the 50's, those optimistic eras before the big plunge and disaster that always ends socialism. In China, they were called "coupons", issued by the government, that can buy goods from government stores. Guess what it's backed by? Absolutely nothing, but the word of the government. Which turned out to mean very little.

Money developed as a portable way of carrying a universally recognized store of value around, the value of various goods and services could be be pegged relative to to that universally recognized store of value. Without a universally recognized store of value, commerce between people and between businesses would be a cumbersome web of barter transactions. Gold and other coinage metals, as well as precious stones filled this role, due to their high value to weight ratio, and almost universal desirability.

When money was in gold or silver, as it was up through the early part of the 20th Century, a shortcut to wealth was to work to acquire gold and silver, rather than use one's labor to acquire other useful goods, such as a textile factory or a sawmill. While there is nothing wrong with gold, it does make pretty jewelry and has useful electrical properties, gold bars in themselves do not benefit their owners. Gold is and was a store of value, but someone had to toil and sweat to extract, refine, and cast the gold bars. The pursuit of gold or other coinage metals reduced the real wealth of the nations. If gold was not needed as a store of value, the labor used to extract, refine, and work the gold could have be used to do more useful things for the citizens of the nineteenth century, such as build more and better housing, farm implements, railways, and so on. Of course, value could be stored in other assets as well, such as oil, steel, or wheat, but oil, steel, and wheat moved up and down in value, and were anything but portable in anything larger than trivial amounts.

Paper money originally developed as a safer and more portable way to transport the value of gold. The value of the note was based on a fixed amount of gold, and conversely, the price of gold was fixed to a certain denomination of the note. Paper money, on the other hand, had the characteristic of being worth nothing in itself. If someone wanted to counterfeit the design on the notes and was skillful enough, he could profitably pass these notes off as the genuine article, and enrich himself. A dirty little secret about paper money though, was that as long as everyone refrained from cashing in their "gold notes" at once, the notes would stay in circulation and nobody would be none the wiser. The only effects would be that if enough of these notes were circulating, the price of goods would be bid up, as more notes chased the same amount of goods. Of course, more goods could be produced to meet the demand, enriching everyone.

This lesson, of course, was not lost on governments either, and not just in finding ways to discourage private counterfeiting. As populations swelled and technology made more goods available and people got rich, people wanted to store their wealth, not only to hoard it, but to make transactions possible in larger and larger denominations, particularly on the commercial level. This bid up the value of gold and other precious metals, which made it profitable to mine gold in quantities greater than was needed for goods actually made of gold. This was the driving force behind the gold rushes of the nineteenth century in America, and what drove wars of conquest worldwide throughout recorded history. All this effort did nothing to improve the lot of people overall, mining for gold sucked people off of farms and out of factories, where goods people could really use were produced, mining despoiled the land, and war has some obvious costs of its own. At the same time, if gold appreciated in value, it became an attractive asset in itself, rather than just a store in value. A wealthy investor might just decide to keep his capital locked up in gold, or in mining gold, rather than venture it importing goods or building a factory. In a growing economy, flooding the market with gold notes quenched the appetitite for people to have a store of value that they could reasonably count on, at least in the short run. This strategy had to be carefully implemented but it worked well to provide liquidity to a growing economy, but left the government treasury vulnerable to a run on gold during the inevitable financial panics. Panics were a regular feature of the nineteenth and early 20th century, and hyperinflation during and in the aftermath of war prompted people to abandon paper money.

In the early years of the Great Depression, money flowed out of business and industry, ironicly into paper money. Money wasn't depreciating, but rather the value of goods relative to money, which in some way was still linked to the value of gold. A somewhat futile strategy was to make it illegal to hoard gold to force economic activity into more useful activities, but it wasn't until 1973 when the gold standard was abandoned. Gold still looms as a "shadow" currency over the economy, but its role in recent years has lessened, and its price is more subject to supply and demand for gold more for its industrial and ornamental uses. The most recent large scale move of money into gold was in 1979 when the price of gold ran up threefold during the near hyperinflation years of the late 70's. When the recovery came a few years later and inflation was stabilized, all of those goldbugs looked pretty silly when the price of gold collapsed to pre runup levels.

While the gold market has been pretty much a yawn for the last 20 years in America, don't count it out completely as a viable alternative to paper money. Paper currency is only as good as the government that issues it. Witness the hyperinflation in recent years in the developing world. The world is a dangerous place, and a widespread disaster in the financial system in the developed world could stir the goldbug's lust once more. When the fertilizer hits the fan and revolution is in the air, people desire a universally recognized, but portable way of carrying wealth.

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