Listen to the words of Federal Reserve Bank Chairman Benjamin Bernake, if you
doubt the truth of this statement. He said in 2002 that the United States government possesses a modern day technology of an electronic equivalent to the printing press that permits it to create all of the U.S. dollars that it wants.
He made later statements about this printing of money that earned him the
nickname of Helicopter Ben, when he claimed that if the U.S. economy ever ran
into real difficulties, then he could salvage it if he only had a large enough
helicopter to fly around the country throwing out bales of this money that was
created out of nothing to the citizens.
Bernake is a professor whose specialty dealt with the Great Depression. His
statements regarding the country’s capability of electronically printing money from thin air may be controversial. You will see below that the truth is that they have 23 - Chapter 2 - Forget What You Think You Know Now – The New Rules of Money
The Silver Fortune Formula - How to Make Extraordinary Profits from the Silver Bull Market evolved into a main component of the American economy in the twenty-first
century.
You have to comprehend how modern money works in order to internalize how a
modern day electronic printing press is able to make money from nothing. The
actual currency of the U.S. does not prove to be the Federal Reserve dollars that move around the United States and its economy. Instead, the real currency turns
out to be Treasury bonds and bills that are backed up by faith and credit of the government.
People, investors, and countries who hold these U.S. Treasuries receive the only
guarantee of being paid by the government from taxes that will be collected from
American citizens in the future. This guarantee to treasury holders is what really
underlies what you use as money in the form of dollar bills.
Fortunately for the U.S. government, the U.S. treasuries’ market remains the
deepest and most liquid on earth. This makes it easy for the Fed and the
government to conjure new dollars out of thin air. The Fed does this by simply
monetizing the debt of the government. In other words, the Fed will step into the open markets and purchase Treasuries.
When they do this, they do not pay with real dollars to the seller of the Treasuries.
Instead, they simply credit the account of the seller for the action. This proves to be Bernake’s electronic equivalent that he had mentioned in his earlier speech. You are right to think that the value credited to the account of the seller does not literally exist. It is merely an on screen balance of the bank’s reserves with the Fed.
With these actions of monetizing the debt, the Federal Reserve has actually printed money from nothing. They are able to do this so long as the Treasuries market
remains so deep and liquid.
24 - Chapter 2 - Forget What You Think You Know Now – The New Rules of Money
The Silver Fortune Formula - How to Make Extraordinary Profits from the Silver Bull Market The transaction also requires sufficient confidence to be present that the seller will accept the crediting of its account by the Federal Reserve. Until either of these two underlying pinnacles is called into question, then the Federal Reserve and the
government will continue to have the ability to literally create money electronically out of nothing through monetizing the government’s debt.
You may be asking yourself a good question now. If the government creates money
from thin air, would this not affect the value of the entire dollar money supply, both that already exists and that they are creating? The answer to the question is a
resounding yes. Later in this chapter you will see start to see how this magical printing of money actually has negative consequences for the demand and value of the U.S. dollar.
Fractured Finance – Fractional Reserve Banking
This creating money by monetizing the government’s debt is not the only way that the Fed is able to create new dollars. They can also use the Fractional Reserve
Banking System that underpins the modern banking of practically all countries in the world.
Fractional reserve banking significantly expands the money supply, or demand
deposits and cash, beyond the level at which it would normally be.
Because of how common the practice of fractional reserve banking proves to be,
the actual money supply found in the majority of nations is a multiple bigger than only the base level of money that a nation’s Central Bank creates.
The multiple itself is known as the money multiplier. This number is set by the
minimum reserve requirement that the financial regulatory authorities require and impose on banks. Extra reserves that banks hold also influence the level of this multiple.
25 - Chapter 2 - Forget What You Think You Know Now – The New Rules of Money
The Silver Fortune Formula - How to Make Extraordinary Profits from the Silver Bull Market You will find that most central banks, including the Federal Reserve, generally set these minimum reserve requirements for the banks. This ensures that banks
maintain at least a minimal amount of their on demand deposits in cash reserves. In such a way, the money creation performed in the commercial banking realm is
controlled by the Central Bank or Federal Reserve.
This is also intended to make certain that banks possess sufficient available on hand cash to deal with typical withdrawal demands. Even though these fractional
reserve minimums are intended to prevent them, difficulties can become evident if a great number of bank depositors attempt to pull out their money at once. This
leads to bank runs on rare occasions. If the problems are exaggerated to banks
throughout a region or are severe, it can also cause a systemic crisis in the banking system.
To help alleviate these types of difficulties and protect the system, the Federal Reserve oversees and closely regulates such commercial banks. It furthermore
functions as a true lender of last resort for them. Besides this, another body, the FDIC, or Federal Deposit Insurance Corporation, insures commercial bank
customers’ deposits.
Because banks are allowed to lend out a certain multiple of the deposits that they actually have, they can be utilized by the Federal Reserve to create additional
money. You have already seen that they can lend out a multiple of the deposits that they have on hand. Another way of putting this is that the Federal Reserve only
requires them to keep a certain percentage of loans that they make as reserves.
Typically, this fractional reserve number is ten percent. This means that for every
$1 that they have in reserves, a bank is allowed to loan out $10. They are given a
money multiplier of ten to one with this reserve.
26 - Chapter 2 - Forget What You Think You Know Now – The New Rules of Money
The Silver Fortune Formula - How to Make Extraordinary Profits from the Silver Bull Market So when the Fed purchases Treasuries by crediting a financial institution’s account, they are electronically increasing the reserves’ value of the bank in question. The bank is then not simply able to loan out these deposits that are magically credited to them digitally, but instead the full fractional reserve multiplier of what is typically ten to one.
This means that the Federal Reserve creates not only the money that they use to
purchase treasuries with, but also the ten to one in new money that is created by
a bank loaning out up to their fractional reserve requirements.
Every modern bank in the United States operates on this system of fractional
reserve lending. This whole explanation may come as a shock to you, as it does to most Americans when they learn of it. Reality is that far more money is loaned out than the banks literally keep in reserves. Although there are restrictions to how much money the banks can create, you have already seen that the restrictions are mostly limited to the ten percent fractional reserve requirement.
Should the Federal Reserve Bank desire it, they can lower the reserve still further, allowing yet more money to be created as if by magic from thin air. This has
profound implications for your money and its value. Later in the chapter we will examine what this means for you and your paper and electronic dollars.
From Something to Nothing – Your Money Now
In the good old days of the 1800s through 1971, money proved to be as good as
gold. This is because until Nixon took the United States off of the gold standard, money was literally exchangeable for gold. This led to an incredibly stable period in the value of the dollar and other major world currencies that lasted for literally more than a hundred and fifty years.
27 - Chapter 2 - Forget What You Think You Know Now – The New Rules of Money
The Silver Fortune Formula - How to Make Extraordinary Profits from the Silver Bull Market When you look at the value of the dollar against gold from 1792 to1862 when the
Civil War had begun, you see that gold closed each year in that seventy year period in the range of $19.39 per ounce to $21.60 per ounce. You witnessed a deviation of no more than 11 percent in the value of gold and hence the dollar in seventy years.
Another way of putting this is that in seventy years, the dollar had only declined around 11 percent against fixed asset gold. Similarly after the Civil War ended and recovery ensued, from 1870 to 1932 the dollar against gold remained steady
around $20 to $22 per ounce. This proved to be another more than sixty year
period where the dollar had no more than a ten percent deviation in value.
Money started its gradual descent to increasingly worthless currency when the
government began to play with the gold standard.
The first real instance of this proved to be in 1933 when President Franklin
Roosevelt decided to intentionally devalue the dollar against gold.
When he declared gold to be worth $35 per ounce against the dollar, he started a depreciation that caused the dollar to fall almost 70 percent from the closing values in 1932 to 1934. It did not matter that the President did this intentionally. This proved to be the biggest single decline in the dollar in its history to that point.
Still, the gold standard last another forty years for the United States, and so long as the government did not interfere with the dollar gold convertibility, the dollar held its value remarkably well once more. From 1935 to to 1971, gold closed every year in a range of $35 to $43.50. These were far more tumultuous years, but the dollar still held its own over the thirty six year period, declining by not even 25 percent despite the challenges of the Great Depression, World War II, and the Korean and Vietnam Wars.
28 - Chapter 2 - Forget What You Think You Know Now – The New Rules of Money
The Silver Fortune Formula - How to Make Extraordinary Profits from the Silver Bull Market The fatal moment for the dollar and other world currencies has already been
described earlier in this chapter. President’s Nixon’s unilateral decision to
withdraw from the gold standard started a stampede for the exits. The gold
standard died an ignoble death over the next few years. This is exactly the point where currency value stability ended, in particular for the U.S. dollar.
From 1970 to 1983, the dollar dropped sharply against gold. It went from a 1970
closing value of $39 to a 1982 closing value of $447, at one point touching a mind blowing $850 per ounce. In thirteen years, the dollar, once a bedrock of stability and value, dropped 1,046 percent.
The fortunes of the dollars value waxed and waned with economic news and cycles
from 1971 forward. The currency had become a paper instrument whose only value
lay in the faith and credit of the U.S. government.
This meant that the value would lie entirely in how creditworthy the U.S. economy and how trustworthy the U.S. government appeared from this point forward. In the years from the 1970 last year of the gold standard, to the prices as of the first of October 2010, the dollar has steadily declined in value over time, despite periodic bounces.
Today’s dollar is valued at $1,320 dollars per ounce. Remember that this level has been reached from $39 per ounce in 1970. The last forty years have represented the most shocking collapse in the value of money in modern history.
The dollar, and most of the other now paper currencies around the world, has
plummeted a staggering 3,285 percent.
To put that in concrete terms for you, had you seen the writing on the wall
regarding the gradual devaluation of paper currencies, you might have sunk your
money into gold to maintain its real value. Your actual thousand dollars in 1970
would today be worth a mind numbing $32,846.
29 - Chapter 2 - Forget What You Think You Know Now – The New Rules of Money
The Silver Fortune Formula - How to Make Extraordinary Profits from the Silver Bull Market This does not represent investment gains that you would have made in stocks,
bond, real estate, or other speculative investments. It is simply how far the paper dollar has declined in value since it officially lost gold’s blessing and backing forty years ago. Can there be any doubt as to paper money’s gradual descent to worthless currency?
Daisies and Dollars – Beautiful to Look At, Impossible to Eat
You may be wondering at this point how it is possible that the dollar has fallen off a cliff to the tune of 3,285 percent in forty years. It is not as a result of the fall of the U.S. economy. Even though the country’s economic leadership has taken its
share of hard knocks in the last forty years, the U.S. economy remains
unquestionably the largest and most vibrant in the entire world.
The other G7 countries of Japan, Germany, Great Britain, France, Italy, and
Canada, plus China, when all combined, still do not surpass the United States’
Gross Domestic Product, or total value of all goods and service produced in a year.
The dollar’s upsetting longer term value problem does not lie with the U.S.
economy or credit rating, or any other single factor.
The dollar’s problem stems from the fact that since President Nixon’s monumental move in 1971, it no longer has any intrinsic value at all. You might be unclear on the notion of intrinsic value. The word intrinsic as described by Merriam Webster relates to a value that belongs to the constitution or essential nature of a thing.
Intrinsic pertains to the inner nature and worth of something based on its own
merits. A diamond has intrinsic value because of its purity, quality, clarity, sparkle, and rarity. Similarly, gold has intrinsic value that results from its luster, color, historical worth, and rarity.
30 - Chapter 2 - Forget What You Think You Know Now – The New Rules of Money
The Silver Fortune Formula - How to Make Extraordinary Profits from the Silver Bull Market
But the dollar, or any other paper currency not backed up by gold, has nothing
intrinsic to it. It is a simple piece of paper with colored ink on it. It is neither
shiny nor glamorous looking. It is certainly not rare.
Instead the dollar’s intrinsic value is now based on perception of its worth. This is much like the value of stocks and similar assets, whose values stem from the
underlying perception of real value that is derived from every business aspect, both intangible and tangible in nature. You are probably asking yourself who decides the perception of the dollar’s worth?
The international currency markets determine any currency’s worth these days
since the gold standard was abandoned. This is more or less done through market
oriented forces of supply and demand. You know that demand for the dollar has
remained strong over the decades.
Even after the hits that it has taken, the dollar still remains the world’s reserve currency for now, as it was back in the fifties, sixties, and seventies. If demand for the dollar continues to be strong, then what explains the 3,285 percent drop in its real value?
Part of the answer is the other side of the supply and demand side of the equation, supply. The government has a long history of printing more dollars year in and
year out. President Nixon did it to the tune of ten percent more dollars in 1971.
Presidents George W. Bush and Barack Obama have engaged in this massive
supply increase of dollars on a scale hardly imaginable a decade ago.
It is no exaggeration to say that the money supply of dollars has been literally
increased by in excess of 300 percent in the last three to four years alone.
31 - Chapter 2 - Forget What You Think You Know Now – The New Rules of Money
The Silver Fortune Formula - How to Make Extraordinary Profits from the Silver Bull Market This supply has dramatically impacted the value and purchasing power of the
dollar as is evidenced by the dropping value of the dollar against gold in a similar time frame.
In the first ten years of the new millennium, the dollar has fallen from $276.50 to $1,320 so far for 2010. This represents a 377 percent drop in the dollar’s constant value against gold. Since the dollar no longer has any actual intrinsic value, it depreciates significantly when the supplies of it are substantially increased.
Confidence is the other factor that lends the dollar its value. Since the value of the greenback is ultimately based on the full faith and credit of the U.S. government, its perceived value has become of paramount importance. Confidence is a funny,
transient thing that takes years, even decades to build up. It can be destroyed in days, weeks, and months.
The Al Qaida terrorists’ declaration of war against the United States with 9/11
represented a blow to the confidence in the nation and its currency. The financial crisis which originated in and centered on bad U.S. investment practices has been another, psychologically more devastating one.
These last few years’ massive increase in government debt to an unsustainable
level of $14 trillion represents still a third. As confidence in the Untied States has eroded over the last ten years, so has the perceived value of the dollar fallen
commiserate with it.
You can expect the roller coaster ride of the U.S. dollar’s value to continue in the future. Until and unless it is once again tied to something of real intrinsic value like gold, its fortunes will fluctuate up and more likely down based on supply, demand, and confidence.
Strap on your seat-belts, it is going to be a bumpy ride.
32 - Chapter 2 - Forget What You Think You Know Now – The New Rules of Money
The Silver Fortune Formula - How to Make Extraordinary Profits from the Silver Bull Market Chapter 3
The Time Is Right for Precious Metal