In Money We Trust (Our Economy)

Stashing cash under the bed is the worst you can do for money because no one can use it.

How does money really work? You don’t need a degree in finance to understand it; just a couple of minutes perhaps to read on and understand why we need money, how it gets its value, and how it gets to you—in short, how money makes the economy go round.

Why we need money

money_2We had tried a lot of ideas to manage the rudiments of buying and selling since we left the caves for civilization. We didn’t really think of paper currency at first. We used barter, but some wanted apples and some chickens. We tinkered with gold and silver, but these coins were prized more than their face value.  Hoarding and melting them to sell as precious metals would disrupt currency flow. We opted for copper, but it heavily favored places with copper mines. Then there were the Yap islanders in the Pacific, the Wall Street bright boys of their days, sans the coat and tie.

Centuries ago, the islanders started carving huge doughnut-shaped disks out of boulders for money. Some could be as heavy as a small car and tall as a small person that stealing them was very difficult. Not that the people kept the coins in their pockets; they left the disks in the same place where the coins were likely minted: along the road, and people knew who owned which coin. When they paid for something, they would sometimes just agree to share a portion of the stone without breaking it apart (it’s hard). It’s silly. It’s primordial. It’s comically out of a Flintstone show, and it’s exactly the concept that we follow today.

It’s the closest antiquated currency to our modern money. The giant disks have a security feature like our dollar:  they’re hand-engraved that it’s hard to counterfeit them. It acts like a debit card that you don’t need to bring cash to purchase something. It performs the function of a thrift bank; you leave it in some secure place, where its sheer size guarantees no one can easily steal them. And it is a stock certificate that can be divided by shares.

We may not need a forklift to carry our currency today, but the same functions are written in stone. It’s our store of unit, a medium of exchange and unit of account to measure the products that we buy.

Why we need banks

Money needs to be circulated so we invented banks. Here’s how banks help to create more money, not in its physical sense, but in exponential value.

Say you pay someone to buy a lawnmower for a $100. In a one-to-one exchange, the $100 stops at the seller and will only re-circulate once the seller buys something. With a bank, that same money goes a long way. Let’s say the seller puts the $100 in the bank. Banks earn money by lending it out with interest to another person. In our example, the bank keeps the 10% as reserves—this is the cap required by law—and lends away the $90 (less 10%) to another person. That person will probably use it to pay for something, too, and the recipient will likely put it in another bank, repeating the process. The bank keeps the 10% as reserves and lends away the $81 to another person, who is likely to use that money to buy another thing. And so on, until the ten percent reserve cut the balance down to zero. In short, banks allow more people to use the same amount of money.

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How money gets its value

moneyOur currency is not backed by gold. In fact, it’s not backed by anything but an idea. Yes, it’s just paper and ink that we can print as much as we want like a Kobe Bryant poster. But we don’t want to print much and the Yap islanders knew why. It’s the scarcity factor. The value of money is intrinsic to its limited supply that to print wantonly will dilute it. We need to believe that our paper currency has value so we make ourselves work hard for it.

Financial experts believe that printing too much dollars and distributing them to the people will result in currency meltdown that leads to hyperinflation.  In English, more people with more cash means more consumers buying more products. More products will be in demand and demand drives prices up. Production will be hard pressed to meet demand, given that more workers are less inclined to get a job since they have cash on hand, coupled with raw materials being more expensive across the supply-and-demand chain. As the dollar dilutes in value, investors will sell their U.S. money for another currency to save their investments, creating a ripple effect that can weaken the economy. Next time someone in the bar says printing more money is a bright idea, run him down with this argument.

This tragedy has been repeated several times in world history, from the Confederate states during the Civil War to Germany in the twenties, and to Idi Amin’s Uganda in the seventies. Recently, the same currency meltdown was seen during the Mexican peso devaluation in the early nineties and in the Asian financial crisis in the late nineties.

How money gets to you

The Federal Reserve Bank of New York says about $829 billion of currency is in circulation. Majority is outside the country, and a trickle perhaps is in your pocket. Here’s how it gets into your wallet.

The Federal Reserve Banks

The decision to print money comes from the Federal Reserve Banks collectively referred to as the Fed. It’s the country’s central bank that monitors the dollar currency flow to stabilize prices and moderate interest rates. In recent cases, the Fed had decided to print more notes and loan it out to banks at near zero rates. This move was intended to control interest rates to counter the housing meltdown in the last recession, but some experts deride it as leaning towards a subsidy, which can  burst the bubble once the financial support plug is pulled out.

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The Fed may decide how many notes to print, but it’s the U.S. Treasury, specifically the Bureau of Engraving and Printing that does the actual printing.

Bureau of Engraving and Printing (BEP)

printing_money_3BEP produces about $1.5 billion a day of notes in its facilities in Washington, D.C. and Fort Worth, Texas, the largest currency printing in the world. However, over ninety percent of these are used to replace old notes or those taken out of circulation, so the country is not getting that much richer in every print run. Incidentally, the coins are produced separately by the United States Mint.

BEP combines state-of-the-art technology and old-world craftsmanship to engrave the design and embed security features in the dollar bill. The government continuously redesigns the bills to minimize counterfeiting. The design includes intricate lines, portrait sketches, anti-counterfeiting features and traditional icons of the American country, which are engraved into steel dies to produce 3-dimensional models.  Only seven people are tasked to do the engraving, and each of them specializes in just a part of the design, such as portraits, vignettes, letters and script. BEP says this makes it harder to replicate the whole engraving.

Technically, the paper is not a paper, but a cloth material made from 75% cotton and 25% linen. That’s why a dollar bill can tolerate numerous folds, but not as much as about 4,000 folds before it tears. Meantime, the paper is fed into an offset printing. The press can handle 10,000 sheets per hour and for every 500 impressions, a staff checks the prints for consistency. The prints go through intaglio engraving for the finish look before the serial number and government seals are imprinted. The bills are cut, piled up into stacks and shrink-wrapped into bricks of cash before being shipped to the Federal Reserve bank.

The new cash, that is, the batch that is added to the existing circulation and not as a replacement, is plowed into the economy when the Fed buys bonds and securities from the banks. As the banks make money by lending out, the new cash streams out of the bank onto the borrower, which can be your company or a business that you deal with or just plain you borrowing money from the bank.


Money is only as good as it is used to purchase something. Even if you save money in the bank, the banker lends it out to someone who is willing to use your savings, in a way. That’s how money works the economy, that during recessions many economists egg us to spend more rather than stash cash under our beds.


Category: Financial News

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