Reserve Currency

Lots has been mentioned here about what Trump can or cannot do. Part of the discussion has been, at least tangentially, about the central bank (the Fed) and its role in the country finances. Perhaps that and the title might be interesting topics to discuss some.

I would hesitate to put myself forward as any expert on anything financial. I know a touch of history, and that can come in useful. So at the risk of being grossly wrong, let me put forward some structure around which to discuss. Hopefully those with better knowledge will correct me where I have strayed.

Central banks and fiat money have been around since time immemorial. The Romans had it, and while I can’t speak to all situations, I believe that all modern nations have created central banks a long time ago. I would submit that the primary purpose of such banks is for governments to manipulate things such as inflation, and to pay for escapades around the world. Depending on your view of the world and national purpose this can be a good or bad thing. No one would really doubt that fighting the Nazis and Germany & Japan were a bad thing. Huge debt was monetized by the central bank. However, note that when the war was over, a Republican congress promptly put the nation back on its economic feet. Yet Calvin Coolidge had huge problems reining in congressional spending, and this was before the bandit Cardozo via his SCOTUS rulings totally trashed any restraint on the fed by the constitution. No court since has been willing to reverse his decisions.

One might remember that the Founders were very much against fiat money. Yet in a real sense, there needs to be some form of fiat currency, simply to allow economic transactions to proceed. These were provided historically by regional private banks that had specie and reputation and so issued bonds against their specie and people took them as safe means of doing business. These banks didn’t hold their positions forever; time and circumstance took their toll and bad decisions might knock a bank out of the place of power.

We have had a central bank since the turn of the 20th century roughly. It was founded when congress once again just about bankrupted the nation (but not the people) by its profligate actions. One of the demands of the bankers who founded it and re-floated the country was that a permanent form of income be created, and so we got the amendment (?16th I believe) that created income tax. Such an idea would have been anathema to the Founders, but progressivism was the rage at the turn of the century. I would submit it’s been downhill ever since.

The Great Depression was basically fueled by FDR and bad decisions on his part on what to do about the economy. So, eg., he personally adjusted the price of gold – by whim. Meanwhile somehow it was thought that there was too much money in circulation so the Fed contracted the money supply. This led to fiat money being created by outside sources, again to basically allow regional populace to buy and sell. So there was a Western fiat currency based upon a bank in Utah (those Mormons certainly know money). Nothing was going to change (much like today) so long as FDR was in charge, and only the onset of WWII allowed for “full employment” to return (?and the lesson for us is …).

?What does all this have to do with “reserve currency”. Well, reserve currency is the currency that the world holds as their specie to back their fiat money. Today our dollar is the world reserve currency. Among some of the benefits is that international transactions are generally done in our currency. So while we inflate and otherwise mess with our economy to see just how resiliant it is, we still have the benefit of buying and selling to other nations in our money. Were we to lose this status (and England once was the world reserve currency but with its waning in the two world wars it lost that status), we would then be forced to buy whatever foreign currency was the new standard, and be subject to the market for the value of our dollar. This is not to say that there are no fluctuations in the value of the dollar; rather it means that we don’t have to subject ourselves to the whims of a foreign currency to do international business.

OK. A dummy’s view of central banks and reserve currency. Speak up, oh experts, and disabuse me of my errors in thought.

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3 Responses to Reserve Currency

  1. MLHMLH says:

    You’re going to make me return to, and finish, The Creature from Jekyll Island</em> aren’t you?

  2. BrentB67BrentB67 says:

    No real errors, some quibbles.

    Fiat currency isn’t required for economic activity. You are correct that the regional bank/currency issue was problematic and a singular currency would address that. There is a general misconception that money supply must increase with economic activity. That isn’t true and it only represses debt not monetary value.

    The Fed wasn’t created, initially, to manipulate currency, it was originally a lender of last resort to back fractional reserve banking. The dual mandate and financing wars of choice, etc. came later.

    16A has nothing to do with the source of income. The source of income is increasing the money supply and consistently maintaining monetary inflation. Income tax isn’t the tax that keeps on giving. Inflation is.

    The dollar’s status as reserve currency has more to do with the size of our economy as defined by GDP and with crude oil being denominated in dollars and the petrodollar trade.

    You are correct that every central bank holds dollars on its balance sheet.

  3. DevereauxDevereaux says:

    I was not clear about 16A. It was not to give the Fed an income but the government a steady income flow to help keep it from going under, something it came close to several times in our history. Each time it was profligate spending. Last bailout IIRC was J.P.Morgan who GAVE the government $30M in silver specie, free and clear, or so I recollect reading somewhere. In my mind this speaks to both the kind of wealth we once had and the sense of patriotism. Can’t think of many who would do the same today – nor have the wherewithall.

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