How the US Fiat Currency Works: An Allegory
We are in the midst of a war of ideology in government where ideas such as Balanced Budget Amendments, austerity measures, higher taxation, and various nefarious other ideas are being raised to solve our National Monetary Crisis. By the time you are finished reading this allegory I hope it will be clear to you why most of these ideas miss the point entirely. And in fact have the potential to create even more damage.
If we are not careful we will be like the man who has run out of gas on the side of the road, and the crafty mechanic tells him that he will have him on the road just as soon as the engine, brakes, and tires are replaced. After all that is done he will still need to put gas in the tank to solve the problem.
That is just about where we are today with our currency system. So not being an illustrator I would like to use the illustrations of your own mind to help you visualize how our currency system used to work, how poorly it works now, and what needs to be done.
Imagine for a moment that the U.S. Treasury is an endless river of currency gushing down a canyon and that without regulating the river we the millions below it will be completely flooded with all our property being destroyed. This flooding of endless currency would make our money useless and therefor destroy our private property which is what our currency represents.
Now imagine a dam placed at the mouth of the canyon. This dam represents the Federal Reserve. At the top of the dam is a very large spillway. This represents the ability Congress has to directly spend money via the Treasury down into the valley of citizens below. And remember behind the dam is an now an infinite ocean of currency.
The real objective of the Federal Reserve and Congress is to regulate the flow of currency so that it always seeks out value. The main way that the Federal Reserve does this is through a “magical liquidity multiplier”, in other words, banks. In a well regulated banking system for every “gallon” of currency they receive they are able to multiply or liquify 5 or 10 “gallons” of currency. The purpose of the banks is to provide currency to places of greatest value. If they are foolish and simply dump the flow of money onto the ground, the magical money liquefier dries up for that particular bank and they go out of business. Through the bank loaning system, currency flows through a massive network of “tributaries” to the millions of businesses and homes that will create a place of value for that money.
For a moment let’s imagine the flow of currency is a bit too high. What are the means we have to control that? Suppose another system of tributaries are created to drain excess currency out of the system. What is this set of “draining” tributaries? It is our tax system. In times of low money supply, a congress that understands how the monetary system works will drain less of the money away. And in times of money oversupply congress will need to drain more money out of the system through taxation. In essence this tax money is really just dumped onto the ground in the effort to regulate money supply. It’s really not needed to provide money for the government. Remember, they have the endless reservoir of money.
So now, let’s revisit the banks. Their objective has been to create a flow of money towards value and to provide a massive network of tributaries in order to reach everyone. But suppose we change their objective. Suppose the objective of the bank now is simply to make money. Nothing more. Ok, wait, so think about this. These banks have special access to the endless Treasury reservoir through the Federal Reserve and they have a magical money multiplier. If their only objective is to make money, why wouldn’t they just make-up various sophisticated “financial instruments”, which they share among each other in the world of magical money multiplying. Of course the outcome of this objective would be to create an environment where money flows to speculation and no longer flows to value.
Think about this a little more. In this speculative environment the money multiplier is really out of control. It could reach multiples of 50 to 80 or even more. Meaning, for every “gallon” of money from the Fed, the banks liquify it into 50 to 80 gallons. Cool! At least for the small group in the magical money multiplying circle. But now what happens to the Fed’s ability to control the flow of money? They think they can go on regulating money the way they used to. If the money flow is low they still think they can increase the flow by lowering interest rates. Which is the valve that makes the money flow more readily. The Fed thinks that in this process the money will be loaned out to that old set of tributaries and flow to the millions who need it. But it never quite gets there.
And this because the banks are too busy speculating, making free money that adds no societal value. And why would they bother making money through the difficult effort of making loans when it is so easy to make through speculation? Something else happens in this process. The flow of money to the people in the valley is now utterly unpredictable. The Fed can no longer really control the flow. The system is built to perpetually create floods followed by drought and more flooding. Continually destroying the personal property of all those in it’s wake.
So as you may have surmised, this is now the state of our currency system. You may wonder, how did we get from a well designed system to one that is so poorly designed? The answer to that is that in 1999, at the behest of Wall Street, congress repealed Glass-Steagall. When Glass-Steagall was repealed the effect was to change the banks objective from making loans to simply making money from the magical money multiplier. The outcome of floods and drought have been inevitable ever since then.
Now for a short review of our currency history. Congress, in order to fulfill it’s constitutional obligation to regulate the currency created the Federal Reserve reservoir system. Then in 1999 it destroyed the Fed’s ability to even regulate the flow of currency. Thus congress handed over it’s constitutional obligation to control our currency over to the banks.
So now let’s return to some of the solutions that are being suggested by congress to fix our National Monetary Crisis. Suppose we pass a Balanced Budget Amendment and fulfill that obligation to balance the budget through austerity measures and higher taxation. How does that help things? Well, first like the man who has a car that has run out of gas, balancing the budget does nothing to “fill the tank”. Or in other word they would be doing nothing to solve the real problem. But even worse they would amplify the problem. While the banks are busy speculating amongst each other and the valley of citizens live in drought, congress no longer can use the spillway to let money flow either! While higher taxation again pulls the money that remains out of a system that is already in drought from the banker speculation.
So where are we?
There are really three things needed to solve this problem.
First you and I need to care enough about this problem to do something! Can we sit idly by while this system destroys us all?
Second, the reason congress destroyed our currency system in the first place is because they represent corporations and not people. We need to amend our constitutional system so that “We the People” are represented and not “We the Corporations”. I will write about this idea more later. May I recommend getting involved with http://www.movetoamend.org
Thirdly of course we need to reenact Glass-Steagall. There is now a bill in congress H.R. 1489 which calls for reenacting Glass-Steagall. If you go to opencongress.org you will see that 58 members in congress are now sponsoring this bill. Interestingly only one of them is a Republican. I have come to the realization that conservatism today resembles the conservatism of King George not the conservatism of our founders.
Please wake up your member of congress to the realization that it is their constitutional responsibility to regulate the currency and not the responsibility of the banks! I especially ask you to wake up those who regard themselves as conservatives. Because it is obvious they are asleep to the most conservative issue of our time.
Protecting the Private Property of Individuals by protecting our currency is what conservatism IS!
By the way. If you want to really understand how our currency system works in more detail, go to http://www.monetaryrealism.com.
It’s a great site.
