A Mental Walkthrough on how the United States monetary system actually works!!

Discussion in 'Political Opinions & Beliefs' started by akphidelt2007, Dec 7, 2011.

  1. akphidelt2007

    akphidelt2007 New Member Past Donor

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    Here's a fun mental activity to start understanding how the country works. Try to conceptualize starting a country from scratch. You have an untapped territory and 1 million humans at your disposal. So now you want to create a fiat currency system exactly like ours. There is $0 in the economy.

    So now you have a million people who need money in order to transact. So the first thing you want to do as the country creator is to build an infrastructure. You take 100,000 of your humans and pay them to build roads, bridges, highways, railroads, buildings, etc. So you want to pay them $1 billion.

    But wait a second... you don't have $1 billion. So what do you do? There are two options... you can take seigniorage of your currency by just issuing it to the citizens. This would mean if you spent $1 billion there would be $1 billion of interest free money in the economy.

    Now that sounds good. But now how do you influence monetary policy? The only possible way in this scenario would be to tax your citizens a variable rate in order to best control inflation. This would be a mess and tax rates would fluctuate on a monthly basis.

    So now what do you do? You introduce the currency through debt. The only way to do this though is to borrow it. But how can you borrow money that does not exist? You set up a bank (aka Primary Dealer)... that will lend you the money. The actual controlling structure to your economy is the banking system. So the banks lend you $1 billion and you give the banks $1 billion in Treasuries which is an interest bearing debt instrument. Your country is now in debt $1 billion. The only way to get out of debt in this scenario is to pay the banks back $1 billion.

    What you gotta understand here now is no one owns this money. The banks lent it in to existence, so if you pay the banks back, based on accounting identity, the money disappears just like it appeared. Now we have a base for pumping money in to the economy. You borrow $1 billion from the banks, give them $1 billion in promises, and give $1 billion to the citizens.

    Now a common misconception is that in America the Federal Reserve creates our money. But let's see how this is not entirely true. In your country the banks have $1 billion in ASSETS, they do not have $1 billion in money. So you create a central bank (aka the Fed). The Fed's responsibility is to make that $1 billion usable in the real economy. Because think about it realistically... right now your citizens have $1 billion in bank accounts but banks have $0 to turn those deposits in to currency. So the Fed creates $500 million in currency/reserves and purchases $500 million of debt from the banks. So you tell the banks that they are not allowed to lend their reserves. Reserves are only used to turn deposits in to currency and for interbank transactions to make sure you have enough cash/reserves on hand to give to your customers.

    So now that $500 million is the basis for fractional reserve banking. Now banks can leverage that $500 million. That is how the Fed influences monetary policy. They do not create private sector money, they do not ever give private citizens money. They simply give the banking system the ability to leverage more money.

    So now what does your country look like? The private sector has $1 billion in their accounts, the banking system has $500 million in reserves and $500 million in Treasuries, the Fed has $500 million in Treasuries, and the country has nothing. They owe $1 billion to the banks and to the Fed. The Government of the United States represents you in this scenario. The essential creator of the country. Replace the word Government with country and it starts making more sense. The country is $1 billion in debt because the country created $1 billion.

    And think about it. As the creator and currency issuer, you are never broke, you never run out of money. If you need $1 billion more to build a military the next year, you simply borrow $1 billion and you are now $2 billion in debt. So no matter what the only money that exists (outside of bank loans) is money the Government (aka the country) has spent. We simply have chosen to introduce the money via interest bearing debt instead of through non-interest bearing seiniorage.

    If you want to balance your budget... then you are essentially saying that $1 billion is all that will ever exist. No matter what the population increase is or the increase in productivity, etc. If you run a surplus, you are taking more money from the private sector than you are giving them. Essentially, you are taking away from the $1 billion you created and there is now less money in the economy.

    The public portion of the national debt is simply the amount of money the Government (aka country) has spent (aka created).

    This is just the basis for your new country. Later we will go in to taxation, inflation, deficits, balance of trade, GDP, and money supply. Lots of fun to be had in the future!
     
  2. Black Monarch

    Black Monarch New Member

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    Wait... the United States monetary system actually works?
     
  3. akphidelt2007

    akphidelt2007 New Member Past Donor

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    Can a MOD delete this thread? It is a duplicate... that I didn't think existed.
     

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