Thursday, September 25, 2008

Fractional Reserve

Our old money was honest. It said what it was, and what it meant. Gold and Silver certificates were like a receipt for a certain amount of "money" on deposit. Even the Government knew which of the look-alike bills seen in As Constant As the Dollar were which.

This one was from our "National Currency", our first Federal Reserve Notes. The banks would honor them for most purposes -- buying a loaf of bread, paying a salary, ordinary trade. What they were not good for was paying taxes or debts to the Government. In that case, only real money "lawful money" would do.

Both types of money circulated, but unlike the fiat currency of today, this fiat currency was kept at a strict ratio with the hard currencies of the time. It provided the liquidity necessary for commerce without diluting the value of the dollar.

Today's currency on the other hand is entirely fiat and is issued by the Governor and researchers of the Federal Reserve Bank based upon the perceived need for liquidity of the current economy. This is a tap-dance on a high-wire. Where anything can trip it up.

Now the currency is backed by our debt, by our willingness to pay in the future for the dollar of today. The baby-boomers are seeing retirement close in on them and are following the (correct) advice of Dave Ramsey and reducing their personal debt. With the intricacies of fractional currency, this reduces the debt backing and hence the dollars in circulation. This is compounded by the increase in loans to members of our society who do not have the ability nor intention to repay or ever carry their own weight. A crash not only was inevitable, it still is, for we aren't even there yet.

Issue an extra 800 billion and see what happens.

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