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Special Edition Five Things: The US Dollar

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Dollars to donuts? We're almost there.

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Every day brings yet one more story about the US dollar. Will the greenback crash? Will it lose its status as reserve currency? What is a dollar? And if we're here in the states, why do we care whether it goes up or down in value against other currencies? Let's take a look at some answers to these questions.

1. What is a dollar anyway? What does it mean?

  • The dollar is simply a banknote issued by the U.S. government that is mandated by law to be used as legal tender for all transactions.
  • Although the dollar used to be backed by gold, today it is backed simply by the promise of the government that it will be convertible in an exchange.
  • Got faith? Good, you'll need it, because faith is the only thing standing between a dollar bill as exchangeable for say, a banana, and just a blank sheet of paper.


2. OK, OK, I got faith aplenty, but where do all our dollars come from and why can't the Fed just print more money?

  • The Fed can print money.
  • And in the wake of the debt crisis and the collapse in real estate values, they are doing so... a lot.
  • Theoretically, every dollar created dilutes the value of a dollar already in circulation, causing it to weaken.
  • But this is only the case if the dollars created go from the Federal Reserve's credit creation mechanism and into the economy.
  • Instead, what is happening now is these dollars created by Fed credit mechanisms are either being horded by banks in anticipation of higher losses, or being used to pay down existing debt, which destroys debt and runs counter to the intentions of making more credit available.


3. OK, so, we're spending more than we're making, and the Fed is printing money to make up the difference. How does the Fed do it?

  • The Fed "prints" money through three mechanisms. The easiest way is through the Fed's Open Market Operations. Through open market operations, the Fed buys and sells, literally, Treasuries that are trading in the "open market." If the Fed buys Treasuries, then the dollars it uses to buy them become available to banks to lend. If it sells Treasuries, the dollars get taken back.
  • The second mechanism is lowering the percent of deposits banks are required to have on hand - thereby increasing the pool of available money to lend.
  • The third is through their "discount policy." The discount rate is the interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank's lending facility. The Fed can grow money by reducing the discount rate.
  • Dollars are literally printed by the Bureau of Engraving and Printing.
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