Insight on money circulation January 13, 2017
Dr. Jerry D. Wilson
Emeritus Professor of Physics
QUESTION: How is money put into circulation, and is the amount of money in circulation constant? (Asked by a curious money-changer.)
REPLY: Well, money is an interesting topic, but it is not the root of all evil – the love of money is (Timothy I 6:10). When you come right down to it, money as we know it is relatively worthless – just pieces of paper and bits of metal, not even gold. The value of money comes in the trust or backing of our government. Money is more or less a means of exchange for something of tangible value.
I don’t think I understand the money system domestically or internationally (and maybe no one does), but I’ll try to answer the questions as best and as simply as I can – that’s what the Curiosity Corner is all about.
New money comes from the Bureau of Engraving and Printing of the Department of the Treasury. For example, some 38 million notes (bills) are printed daily with a face value of about $541 million dollars, 48 percent of which are $1 notes. (Check your paper money; it is Federal Reserve “Notes.”) Each year, 95 percent of the new notes printed are used to replace notes already in circulation that get worn out or damaged.
So, who does this replacing? The Federal Reserve System. Established in 1913, this is the central banking authority of the United States. It acts as a fiscal agent for the U.S. government, is custodian of the reserve accounts of commercial banks, makes loans to commercial banks, and is authorized to issue Federal Reserve notes that constitute the entire supply of paper currency of the country.
The Federal Reserve (the “Fed”) controls the money supply in circulation in several ways. One is the reserve account mentioned above. The Fed can adjust the legal reserve ratio – the proportion of its deposits that a member bank must hold in reserve. Basically, this means that a bank has to have a certain amount of money on hand and can’t lend it all out. (If we all went to our bank and wanted to draw out some money and they didn’t have it, we’d be a bit upset, no?) So, the greater the reserve ratio, the less money the bank has to lend or put into circulation.
However, the money supply is most commonly manipulated through the discount rate. This is the rate of interest the Fed charges member banks on short-term loans, typically to maintain the reserve level. Let’s not get too technical and do an example: Interest rates are low, so you go to the bank and borrow $1,000 to buy something, which you do. Now there’s $1,000 in new bucks in circulation (not in the bank vault). If a lot of people do this, there would be a lot of bucks out there – money is cheap, and we start to have inflation. So, the Fed raises the discount rate to the bank, and the bank has to charge a higher rate for loans. People quit borrowing, others repay former loans, and there is less money in circulation. So, the money supply fluctuates and is not constant.
Told you it was a tough subject. If you’re confused, start at the top again. If that doesn’t help, send money (just kidding).
C.P.S. (Curious Postscript): “I never made a mistake in my life. I thought I did once, but I was wrong.” – Charles M. Schulz
Curious about something? Send your questions to Dr. Jerry D. Wilson, College of Science and Mathematics, Lander University, Greenwood, SC 29649, or email firstname.lastname@example.org. Selected questions will appear in the Curiosity Corner. For Curiosity Corner background, go to www.curiosity-corner.net.