Thursday, July 02, 2009

Where does money come from?

I'm no money-mommy, but I nevertheless get asked occasionally where money comes from. And when I am asked the question, I clear my throat, cough, sniff, and shuffle. The question embarrasses me not because I know how to make money and am ashamed to admit it, but rather because I call my myself an economist and don't know what money is.

Until now. Here is a storky story.

In the beginning, there was gold. People found gold in the ground, and the gold was money. And the money was good.

Then there were banks. People put gold in banks to get paid interest and to keep the gold money safe. The bank printed gold receipts to hand out to people who put gold in the bank. These receipts came to be known as money, and the receipts were exchanged like money because they were as good as gold, as long as the bank followed good business practices such as not loaning out too many gold receipts for gold that didn't exist in the vault.

Then the government printed a bunch of Federal Reserve Notes (normal modern currency) and forced banks to give up all the gold that had accumulated in the vaults in exchange for the new federal currency. Now banks had federal currency in the vault instead of gold, and when people came to the bank to withdraw savings, all they could get was federal currency, so it quickly replaced most other forms of money for everyday transactions.

Nowadays, the Federal Reserve makes money by instructing banks to write big numbers in the banks' customer accounts. Suppose I am poor and I've just convinced the Fed to bail me out. My bank account at Bank of America has no more money in it. The Fed loans me $1,000 by telling the bank to type "$1,000" into the file that says how much money I have in my account. This gives the bank permission to call up the US Bureau of Engraving and Printing and order in $1,000 in fresh crisp twenties. When the twenties arrive at the bank in the armored vehicle, the bank writes a note for the auditors. The note says, "That $1,000 in currency we received now represents the $1,000 that the Fed told us to write in that guy's bank account." Now I can go pick up my money at the bank whenever I want.


Blogger Mama JJ said...

Thanks for the simplicity. Just might read it to Yo-Yo for an economics lesson 101.

7:14 PM  
Anonymous dr perfection said...

so where is the gold kept now? Does it exist?

5:29 AM  
Blogger My Freakwentness said...

The US has about 8000 tons of gold (about 5% of total ever mined), and it is all kept at Fort Knox or Manhattan.

2:13 PM  

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