Overview of United States Monetary System
The United States dollar used to be backed by gold; however, in 1971 the US officially withdrew its promise to convert dollars into gold. The US dollar is now considered fiat money because the value of the dollar is derived from legal tender laws that require people to accept dollars as payments of debt. Since there is no physical limit regarding the amount of unbacked dollars that can be created, there is very little preventing inflation of the US money supply.
Inflation of the Money Supply
One source of inflation of the US money supply is the Federal Reserve. The inflationary process starts when the government wants to spend money so the government issues securities in exchange for existing money. The Federal Reserve, if it so chooses, then has the ability to purchase these government securities with money the Federal Reserve can create out of thin air. If you ignore the middleman who buys securities from the government and sells them to the Federal Reserve you see this process basically enables the US government to spend money created out of thin air by the Federal Reserve.
Another source of inflation of the US money supply is through the practice known as fractional reserve banking. This process could be explained in a paragraph but an ultra-short summary is that fractional reserve banking allows banks to lend out multiple times more money than they have on reserve. Essentially banks inflate the money supply by loaning dollars that aren't even backed by unbacked dollars.
The Problem with the System
In theory, inflation of the money supply that is caused by the Fed and by the Banks would eventually be reversed as the loans were paid back. However, this isn't what happens in reality. Instead, the money supply keeps being inflated because new money is loaned into existence faster than loans are being paid back.
For example, for the 38 year period from 1971 to 2009 the component of the money supply used by economists to evaluate the amount of dollars in circulation, M2, increased by a factor of 13.
It is not entirely a coincidence that an ounce of silver costs roughly 13 times more in 2009 than it did in 1971.
The absence of physical limits on inflating the money supply enables excessive government spending and debt.
For example, the budget totals on whiteshouse.gov for 2009 show the government spending $3.998 trillion and collecting only $2.157 which translates to a budget deficit of nearly $2 trillion.
This type of deficit spending adds to our massive and growing national debt.
I just checked our national debt and it is currently $12,004,593,275,961 which calculates to $38,981 per person or $110,495 per taxpayer, and by the time you read this it will have grown.
"The Federal Reserve sets the nationís monetary policy to promote the objectives of maximum employment, stable prices, and moderate long-term interest rates." - The Federal Reserve
» Continue to Chapter 2: Inflation is Not Natural
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