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Money makes the world go round. Yet in the end it’s just a piece of paper, backed up by a bunch of hot air. It’s only value is found because we are forced by law to use it. You cannot print your own and most places around here don’t accept foreign currency. It is the only thing approved by the United States Government for use and you will be arrested if you start issuing your own notes.

I am not an insider at the US Federal Reserve, however I do know that they have been holding auctions for hundreds of billions of dollars. These auctions are so that Banks can stay liquid and keep lending money. Last time I checked it was 75 billion. They’ve had 13 of these auctions. (Herald Tribune Article, June 3rd 2008). Where is this money coming from? Depositors at banks? I think not. I don’t think the fed usually keeps 75 billion on hand, wouldn’t it be better to have it invested? Are they not just printing this money up, or actually just creating it out of thin air? Does anybody know the answer to this question? As I was typing, I got curious and looked it up. I did know already that we are on a Fractional Reserve Banking system in the United states. I learned that this allows the Fed a lot more freedom in where it comes up with money. For more information on Fractional Reserve Banking, compare these sources, (lewrockwell.com article), (Wikipedia entry), (Encarta entry) The Encarta article points out that money is created when a bank makes a loan and it is destroyed when the loan is repaid. I don’t agree. Once money can be created from nothing, what separates real money from created money? It’s all real enough. A 10 dollar deposit, turned into a 100 dollar loan, which is used to buy a house, (we’re keeping things simple) puts 100 dollars that wasn’t there before into the economy. The economy has grown by 100 dollars, which the seller of the house now uses to deposit into a bank account. The 100 dollars is then used to make a loan for 1000.00 dollars by his bank, and so on. While the loans are repaid, the banks keep the interest. So money is earned on created money, causing inflation, and while some of it is reversed as the loans are repaid, there is still inflation.

The same encarta article brings out, and I quote directly from their entry:

The real value of the dollar today depends only on the amount of goods and services a dollar can purchase. That purchasing power depends primarily on the relationship between the number of dollars people are holding as currency and in their checking and savings accounts, and the quantity of goods and services that are produced in the economy each year. If the number of dollars increases much more rapidly than the quantity of goods and services produced each year, or if people start spending the dollars they hold more rapidly, the result is likely to be inflation. Inflation is an increase in the average price of all goods and services. In other words, it is a decrease in the value of what each dollar can buy. see Inflation and Deflation.

So if production of dollars has increased rapidly, perhaps by auctions of hundreds of billions of dollars, or by people using their inflated equity in their houses to purchases collective billions of dollars worth of consumer goods, the amount dollars buys decreases? Could that explain why gas prices have more than doubled since this housing crisis started in 2006? Opec won’t increase production, until the market calls for it. Demand has not increased enough to warrant this type of price increase. Food prices are up as well. Some blame ethanol. I tried to hunt down some statistics that support my theory that food exports from the US are up, but I couldn’t find any in the few minutes I searched. However it would make sense that if you’re selling grain to europe, and getting paid in Euros after the drop in the dollars value, now means you’re earning a lot more dollars for the same amount of grain.

After reading all of this, money now seems like a little bit less of a priority for me. People kill for this stuff and yet people don’t understand how it works or where it comes from. Everybody wants to be rich but figuring out how to become rich to most people means working more hours or climbing the corporate ladder. I think what people really need to do is figure out what rich really means to them. Lots of money is trivial. The value of it changes daily, perhaps not by huge amounts but over time it does. My dad told me his first real job paid 12,000 dollars a year and he felt like he was making huge amounts of money. In 1995 my dad was earning 40k and supporting 5 people on it. Today I earn 40k and I can barely support myself. So piling up a huge nest egg, means nothing in the long run. 300,000 dollars won’t buy you anything in 70 years. Who remembers when 1,000,000 dollars was a lot of money? Today if you had a million dollars in the bank you’d keep working. It’d be nice, you’d be comfortable, but it’s not enough to retire on is it?

The only way to be comfortable is to be able to generate passive income. My family realized this about 2 years ago. We bought some houses in Michigan, the first one we paid 3,000 dollars for, with a total cost after clean up and rehab of 8,000.00. We sold it for 32,000.00. The person who bought it pays monthly less than she was to rent an apartment that was literally falling apart. She will keep paying us for the next 15 years, or until she refinances. The total of her payments will be over 54,000.00 dollars from an initial investment of 8k. We invented 24 thousand additional dollars out of thin air. Just like the banks do…riches are earned in time and freedom, not dollars. That 46k we created, out of thin air spread out over 15 years is a little over 3k a year. Not enough to retire on either, but it’s just the start. We have to do nothing to make sure we keep getting paid. If she stops, we foreclose and resell a property that the owner has spent time fixing up and resell it again. This time it cost maybe a few hundred dollars to take back through legal fees and resold for 62k the next time. Who knows? It’s about generating capital, not earning a salary anymore.

If you’re reading my blog, I want feedback. I want your ideas, I want your opinions. What have you done to better understand the monetary system? What parts of my post do you agree with, disagree with?