There are an awful lot of people who don’t understand how the modern monetary system works. If you were to ask 100 people at random what institution is responsible for printing money, I’d expect 70 of them to name the U.S. government. Actually, it’s the Federal Reserve, which is technically an independent entity. Most people don’t realize that when the federal government borrows money, it doesn’t even pay it back; that’s left to the Federal Reserve, which pays it back by borrowing more money or just printing it. And while Federal Reserve vaults do hold large quantities of gold, most of it doesn’t belong to the U.S. There is nothing backing U.S. dollars except the full faith and credit of the U.S. government–and force.
So here’s how it works: The Federal Reserve is the source of all U.S. dollars. Its major activity consists of loaning money to the federal government, which spends it. The federal government also demands payments from people who produce things. These demands give money its value. Money spent goes to the people of the U.S., who both buy and sell various goods and services–including capital–to the rest of the world. The people also carry out transactions with the Federal Reserve, buying and redeeming government bonds.
Between every major actor in the monetary system, the flow of money is two-directional–except between the federal government and the Federal Reserve. Money flows from the Federal Reserve to the federal government, but it does not flow back. But the Federal Reserve can only print money; it can’t create wealth. So the wealth represented by the money that it prints and loans to the federal government can only come from the diminution of capital–inflation, the collapse of the housing market, stock market crashes, and so on.
A little bit of inflation forces the wealthy to generate economic activity to maintain their fortunes. But if the government spends too much for too long, the economy stops functioning. It’s a tricky issue. But politicians at the federal level must address it or be replaced by their successors.
