What is Money Made Of – Introduction
We all are aware of what money is but how did it come into existence? In ancient times, there was a barter system that allowed people to buy one good in return for another good. Then around 770 B.C., the Chinese started using small bronze replicas which later became coins. So, China gave birth to the currency. However, it was in Lydia (Western Turkey) where the first manufacturing facility of the coins was established.
Later on, China moved from coins to paper currency which has become a preferred method of monetary exchange in the modern world. The modern world has innovated to an extent where we even have digital currency like Bitcoin as means of exchange. But today we will talk about how the dollar currency is printed in the economy.
Failure of Gold Standard
Even before the US Dollar became a fiat currency, the economy was heavily dependent on the Gold Standard Monetary system that allowed the USD to be backed by gold. Back then the precious commodity gold, decided how the currency would be valued.
The United States printed its first paper currency in 1861. A Gold Standard Act was established in 1900 that allowed gold as a commodity to be used to redeem the currency. In 1913, the Federal Reserve was created to maintain stability in the currency value and gold prices.
However, after World War I, many countries abolished the gold standard as they believed it did more harm than stimulate economic growth. The Great Depression of 1929 caused great chaos as the banks failed to make promised payments leading the common public to hoard gold. Back in 1960, the United States held the majority of the gold reserves valuing up to $19.4 Billion.
As the US had the majority of the gold reserves, many countries started valuing their currency against the US Dollar instead of gold. In 1963, the US Dollar became a fiat currency that was not backed by any precious commodity.
Check the next section to know what money is made of.
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Printing the US Dollars – What is Money Made Of?
The Federal Reserve in the United States is the central bank authority that is responsible for supplying money to the economy. There are two departments of the Treasury system that supply money to the economy.
Bureau of Engraving and Printing – This department prints the currency (paper money) in the United States.
United States Mint – They produce the coins for the economy.
The Federal Reserve keeps track of the money supply in the economy. Each year the Fed gives an order to the Treasury departments for printing the currency. Through its armored carriers, the Fed then transports the money to its cash office at 28 locations. The cash offices are responsible for distributing the money to the banks and other financial institutions in the country.
If you are studying finance or work in the finance industry, you must have heard the phrase, “Fed is printing money again”. This usually means that the Federal Reserve will be increasing the money supply in the economy. Fed is prominent for using their ‘Quantitative Easing’ program for increasing the supply of money in the country.
Printing Money Using Quantitative Easing
Fed’s most well-known yet controversial asset purchasing program called Quantitative Easing is just another name for open market operations. Does that mean that the Fed creates money out of thin air? Simply speaking, the Fed just buys the asset from financial institutions through the money it creates for the economy. So, yes, in other words, the Fed creates money through its perfect computation on various models.
But how does the Federal Reserve manage to purchase the bonds and other securities? The Fed does not pay for anything using paper money. Steve Meyer, a member of the Fed’s Board of Governors once revealed that the Federal Reserve uses the electronic fund to pay the bank selling the asset. The seller’s bank then adds this money to the seller’s account. That is the most convenient way of doing the transactions for the central bank.
Dangers of Printing Extra Money
This is a common question for everyone who wonders what money is made of. In FY20 (January to December 2020), the Federal Reserve’s Board of Governors had ordered over 5.2 Billion Fed notes to be printed by the BEP. It was valued at over $146.4 Billion. During the peak of the pandemic, the Federal Reserve had decided that they will print $3 Trillion worth of money to pump it into the economy. The Federal Reserve’s balance sheet stood at $4.16 Trillion as of February 26, 2020.
However, by June 10, 2020, this almost doubled to $7.17 Trillion as the Federal Reserve printed $3 Trillion worth of currency in three and a half months’ time frame. The money printing was mainly done by the Federal Reserve as an exercise to support the economic turmoil brought by the Covid-19 pandemic. But what comes after excess money supply in the economy? The risk of inflation.
By now anyone who has studied economics in college or at a later stage in life is aware that excess money supply in the economy leads to inflation. Why would the Federal Reserve risk the exposure towards inflation by printing such a huge figure? Well, the idea of printing more money was to decrease the interest rate on the debt that would enable the citizens and the businesses to borrow with ease. In other words, the Federal Reserve wanted to revive the economy at a faster pace after the pandemic.
Final Note – What is Money Made Of?
The Federal Reserve is the sole authority that prints the money in the United States. Although, in recent times the Fed has been criticized for supplying excess money to the economy by buying back assets through quantitative easing. However, the Fed said that the economic revival is still on track and the monetary policy withdrawal will take place eventually. Hopefully, this article answers your curiosity about what is money made of?
Frequently Asked Questions
Why do people criticize quantitative easing?
The critics believe that quantitative easing will eventually lead to hyperinflation while people still argue that it is necessary for economic growth.
Who prints money in the United States?
It is the function of the Treasury Department. Specifically, the Bureau of Engraving and Printing is responsible for printing although the number of new bills to be printed is informed by the Fed.
Which dollar bills are most in circulation?
At the time of writing, the $100 bill is the one that is being circulated the most.
Why is the money not printed by the Government?
Government printing the money can lead to the devaluation of the currency held by the common people. Hence, the government borrows the money and uses the citizen’s taxes to repay the debt.
On what basis does a country decide to print its money?
A country prints its currency based on the value assigned to its economy or in simple words, based on GDP.