Assignment 16 - Benjamin Givens

If you have some money—whether it be from a job, an investment, or inheritance—you put that money in a bank. It would be extremely cumbersome to keep the cash around. It almost seems ridiculous to us. But what happens to that money when you put in a bank? It doesn’t stay in the bank vault and most people know that. It gets invested in a way that is useful to society. Much more useful than keeping money. Because money sitting somewhere doesn’t get us anywhere. It just sits. It has no velocity. If someone holds on to money, then nothing happens. It doesn’t change in value and it doesn’t provide a service—you can’t eat money, you can’t live in money, you can’t do anything with money that sits. Money is useful when it's spent. This is where the bank comes in and the idea of “Fractional Reserve Banking.”

The bank gives that money to people in the form of a loan. However, it doesn’t give out money without purpose, but instead puts it to specific projects. For instance, to buy a house, to start a business, to make a park. In return for the cash that is used to pay workers and buy capital, the bank gets a lien against the purpose of the investment. This is a legal piece of paper that says, “They owe us money for that project, and if they can’t pay it back, that item becomes ours.” The bank is not giving away money. It still has the same amount of assets. But now that money is in a form that is useful to society. A park being built is much more useful than money sitting in a vault. This is the “banking” part of fractional reserve banking.

The “fractional reserve” part is that while this movement of money is great for the economy, it’s not so great for you personally. You want to be able to go to the bank and withdraw your money. If it is all in the form of an asset like a lien against someone’s house, it doesn’t do you any good. Thus, the federal government mandates that the bank keep a certain fraction of the money they owe people’s accounts “in reserve.” What happens is that if you put 100 dollars into a bank and there is a 10% reserve requirement, 90 dollars get loaned out. That money is also put into a bank, with 9 dollars reserved and 81 loaned out. This process keeps happening and this case will eventually mean that around 100 dollars of deposit results in around 1000 dollars in the money supply.

Under this system, putting money in the bank allows for a lot of commerce to occur and in a way that is very easily controlled by the federal government. Printing more money and setting the reserve percentage allows you to calculate what the value of money will be.

Many people heard “printing money” just then and thought “bad.” This is the general reaction. When people think of printing money, they think of hyperinflation in 1920’s germany or 2009 Zimbabwe. This is one of the central argument for the gold standard. It puts a hard limit on inflation. How does it do that exactly?

Well, in the gold standard, dollars are worth a set amount of gold when they are issued. You could, theoretically, exchange those dollars for gold at any time. Of course, this system makes the same assumption that the modern fractional reserve system makes: people are going to demand vast quantities of gold at once. In this way, the size of the economy is limited by how much gold is being used to back dollars and the percentage of that gold that is physically held.

This system is effective at limiting inflation. You are guaranteed a certain value that your supply has that is equal to the gold that is backing it. You even see a deflationary effect. Because the size of your economy will grow, while the size of your money supply does not. For certain individuals this is a fantastic development. Simply by holding to your money at essentially no risk, the value of your money will increase.

This sounds great, but of course there is cost. In the “saver’s economy” that deflation creates, the optimum play is not to invest money, but to keep it in piles. I hope have impressed on you the crucial fact that money sitting around is worthless. It doesn’t allow people to access goods. It doesn’t allow people to buy houses. It doesn’t allow people to build businesses. Money on its own does us no good, and backing it by gold does not give it any more value. Gold sitting around doing nothing is just as worthless as any other representation of wealth sitting around doing nothing.

Some amount of inflation is a good thing to motivate people to invest money. To motivate banks to loan out money for projects. Hyperinflation is the fear in a currency that is not backed by a limited resource like gold. However, it has not materialized in our modern U.S. dollar that is not backed by gold.

The costs continue to grow when you consider the fact that the U.S. runs at a trade deficit. It exports more money that it imports. If we relied on the gold standard, we would run into the problem of our gold supply shrinking.

Some proponents of the gold standard claim it is a more stable asset, but in reality it is just as worthless on its own as any other item. There is no particular reason that a house is worth a thousands ounces of gold as it is worth a thousand dollars. It is simply a value that we all have agreed upon. Thus regressing back to the gold standard is silly. We have all agreed that dollars have value, so they serve the purpose of gold without its supply limitations.

Despite the clear evidence that the gold standard would hurt the economy, there still remains those who would pull as back to a system developed in the 17th century. Investment agencies that handle large sums of cash advocate for the advantages of deflation—and why wouldn’t they with their large sums of money that would stand to gain value in such a system. f the efforts of these large money holders were successful, it would be an affront to Democrats and Republicans alike. the problems of deflation hurt the economy as a whole and disproportionately affects the poor that don’t have the ability to capitalize off savings making money. The standard also prevents any semblance of trickle down economics, since the wealthy have no incentive to invest into the economy.

Works Cited

Allie, Eric. "Political Cartoon on "Fool's Gold"" Townhall. N.p., 9 Nov. 2010. Web. 10 Dec. 2016.

Khan, Salman. "Khan Academy." Khan Academy. N.p., n.d. Web. 10 Dec. 2016.

"Merk Insights - Bernanke's Problem with the Gold Standard." MERK Funds. Merk Investments, 27 Mar. 2012. Web. 10 Dec. 2016.

Status Report of U.S. Treasury-Owned Gold. Rep. Department of the Treasury, Bureau of the Fiscal Service, 30 Sept. 2016. Web. 9 Dec. 2016.