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We discuss the Gold Standard, why it is used and what its drawbacks are. We also discuss the creation of the Federal Reserve System and how we slowly moved to fiat currency.

  • Gold standard
    • Came before the federal reserve system (and existed during it as well)
    • People like gold for money because it is rare and durable
    • A dollars value is fixed to a quantity of Gold (or silver)
    • Bimetalic system would use two metals - typically silver and gold
      • Hard to keep in sync because the values fluctuate
    • Metals have industrial uses
    • Inherently deflationary if the value stays fixed
    • If it’s not fixed, how different is it than fiat currency?
  • Federal Reserve
    • The Federal Reserve bank is more than a plot device in Die Hard 3
    • To understand it, you have to understand fractional reserve banking
    • At its simplest, the idea is that the bank takes some of the money it has on deposit and uses it to issue loans
    • These loans increase the money supply
      • Bank has $1,000,000 in deposits and can loan out 90%
        • First loan: $900,000
        • Then $810,000, $729,000, $656,100, $590,490, etc
        • Before the value gets to under one cent, it can be loan 182 times
        • The total amount of money from it becomes $10 Million
        • The reciprocal of fraction that is retained (i.e. 1/10th) becomes the multiplier (i.e. 10x)
        • This is called the money multiplier effect
    • Bank runs & reserve limits
    • Lender of last resort
    • Money creation (plus interest) tends to freak people out
    • Paying a loan undoes the money multiplier with the same multiplier effect
    • Interest growth means that the outstanding loans require more money but remember the economy is usually growing
    • The federal reserve sets an inflation target (2%) and uses lending rates and reserve percents to try to achieve that
    • They are also in charge of ordering money from the US Mint
    • It’s a public entity with a quasiprivte part
      • Congress charted it, oversees it and the president nominates the chair
      • To be a member bank, you must hold shares in your regional bank
      • Profits are spent on staff and dividends. Anything left over goes to the treasury (a very indirect tax!)


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