• Home
• Personal Finance
• Economy
• New School
• Asked & Answered

• ABOUT
• FAQ
• RESOURCES
• ADVERTISE
• CONTACT

Our Economy needs U.S. Dollars

This is the nature of our fiat currency system.  Many people, particularly mainstream economists, mistakenly believe the opposite - that our government needs our money.  Many people hate this idea and many are in denial about the reality of it but that’s what it is.

Before 1933 we had the Gold Standard as a monetary system.  This meant that a certain amount of gold was backing the U.S. dollar.  The issuance of money was limited by the amount of gold with the Federal Reserve Bank but it also meant that the value or price of the dollar was fixed.  Obviously this also limited the Fed’s ability to manage monetary policy. 

The Gold Standard was seen as means to stabilize currencies, encourage thrift, and impose fiscal discipline on governments.  But the Great Depression changed all that.  As unemployment steadily spiraled upward and prices including wages started to fall, the Hoover Administration and the Fed remained determined to stick with the Gold Standard even if this meant limiting government’s ability to respond to the economic crisis.  At first, both the Hoover Administration and the Fed decided that inaction was the best policy and that preservation of the gold standard should be the priority even if it meant higher unemployment and much lower economic output.  This meant that the supply of money and bank credit were at the mercy of the supply of gold on hand at the Fed. 

But the supply of gold worldwide was limited and with central banks around the world clamoring for gold many, including the Fed, decided to jack up interest rates to attract it.  Obviously, higher interest rates during a severe downturn in the economy is not good.  This resulted in bank closures which disrupted the credit process for businesses and households.  Despite rising bank closures, even higher unemployment and even lower economic output adherence to the ideology of the Gold Standard was maintained. 

That was until something started happening.  Civil unrest began to emerge and people, particularly labor unions, began to organize as formidable challenges to the political and economic status quo.  The 1932 Presidential election provided an opportunity for change.  One of FDR’s first acts (via Executive Order), in March 1933, was to abandon the gold standard.  Many economists believe this act was the beginning to the end of the Great Depression.

However, after World World II, existing world powers came together to form a ‘gold exchange standard’ under the Bretton Woods Agreements.  Under this system the U.S. dollar became the central currency for global trade with many countries pegging the value of their currency to the U.S. dollar.  The U.S. dollar was in turn fixed to the price of gold ($35 per ounce).  Then in 1971 President Nixon ended the ‘gold exchange standard’ as a result of the cost of Vietnam War, rising inflation and other countries draining U.S. supply of gold.

Today, as result of Nixon’s actions, we have a fiat currency system.  This means that the only thing backing the U.S. dollar is the full faith and credit of the U.S. government.  Most countries in the world have the same fiat currency system.  The change to the fiat currency system should have changed economic thought as well but it didn’t.  What we have are many economic theories, ideologies and concepts that are still stuck in the gold standard frame of thought and are still being taught in schools and espoused in traditional media. 

One example of this old frame of mind is this notion that federal government is running out of money.  This is a huge myth and not possible with a fiat currency system.  Fiat currency is nothing more than clicks of a mouse or entries on a spreadsheet.  Certainly the federal government cannot run out of entries in a spreadsheet (unless of course there’s a massive computer failure).  Consider the recently disclosed information of the Federal Reserve loaning the global financial sector and big corporations $3.3 TRILLION.  All the fed did was credit bank accounts via entries on a spreadsheet and viola - $3.3 trillion was created. 

Another mythical notion is that the federal government needs our money to finance spending.  FALSE.  Federal government with a fiat currency system is NOT revenue constrained.  If it was we would have in trouble years ago and two wars plus a +$700 billion Wall Street bailout wouldn’t have been possible.

What was that - federal government may not be revenue constrained but it just keeps borrowing and borrowing and borrowing.  Yes it does, but it doesn’t have to.  It does so because of old vestiges of the Gold Standard that require Treasury Department to not have an overdraft on its general accounts at the Federal Reserve (U.S Treasuries do allow Fed to manage short-term interest rates).  Certainly with the limitations of the Gold Standard such a requirement was necessary.  But not now. 

So why does our economy need U.S. dollars?  Well, most, if not all, private sector transactions are conducted in U.S. dollars.  But most importantly the U.S. dollar is the legal tender and it’s the only currency that the government will accept for the payment of taxes and other transactions with it.  And if there’s a recession or economic slowdown this means that government spending is too low or taxes are too high.  What it boils down to is that deficits create private sector savings which last time I checked were a good thing.  Here’s a diagram that summarizes what is happening:

Source: Deficit Spending 101 - Part 3

Now, before people go off on fiscal profligacy or even inflation.  Let me say: 1) Sure there is such thing as wasteful government spending but there are other means to address wasteful spending; and 2) government spending CAN cause inflation - but it’s not automatic - just look at are current economic situation.  Let me go further regarding fiscal profligacy - how about a standard and I offer it strictly as a point of discussion - if spending or even tax cuts do nothing to further a public purpose such to promote job growth or improve/maintain a living standard for people then don’t do it. 

Good luck.