Comments (20)

• Mike Sproul

  Block's assertion that the dollar has no backing is, unfortunately, the mainstream view. He fails to see the difference between a currency that is truly unbacked, and one that is backed but physically inconvertible. The Federal reserve holds gold and US bonds as assets against the dollars it has issued, and the Fed stands ready to use its bonds to buy back those dollars. If Block, or anyone else, can ever find a central bank that holds NO assets against the money it issues, then they would have a case for claiming that a currency is unbacked. Until then, they should at least learn something about the real bills doctrine.
  

  Published: January 1, 2008 9:22 PM

• Don Lloyd

  Mike,

  The Federal reserve holds gold and US bonds as assets against the dollars it has issued, and the Fed stands ready to use its bonds to buy back those dollars.

  Issued dollars and held assets have nothing to do with each other in the absence of a legal requirement to exchange one for the other.

  If I, you, or anyone else has a Federal Reserve Note, our only recourse is to find a willing exchange participant that prefers it, or an unwilling exchange participant who can be threatened into exchanging anyway.

  Money, per se, doesn't require backing.

  Regards, Don
  

  Published: January 1, 2008 10:04 PM

• Josh H

  Mike,

  As Don said, I don't believe the US is required to exchange dollars for gold anymore. But even in the case it was required to do that, the government is sitting on only $207bn in gold, while M0 is $749bn (Dec 2006). If the rest is to be backed with bonds, we're on shaky ground, since bonds are simply a promise to pay dollars. Somehow, backing a piece of paper with a promise to deliver more pieces of paper in the future seems a bit circular.

  Published: January 1, 2008 10:21 PM

• Mike Sproul

  Don Lloyd:

  There are two kinds of convertibility: (1) Physical convertibility, where the Fed buys back its dollars with a physical amount of gold, wheat, etc., and (2) financial convertibility, where the Fed buys back its dollars with its bonds. The dollar is not physically convertible, but it is financially convertible, as long as the Fed conducts ordinary open market operations. As long as financial convertibility is maintained, physical convertibility is normally irrelevant.
  This is explained at
  www.csun.edu/~hceco008/realbills.htm
  

  Published: January 2, 2008 1:29 PM

• Mike Sproul

  Josh H.

  The Fed could, if it wanted to, use its $749B in bonds to buy back $749B in paper, and then burn the paper. If there are any paper dollars left (unlikely), the fed can buy them with gold and then burn them. Backing a dollar with bonds that are denominated in dollars is actually not circular. A stock market analogy: Let's say Merrill Lynch issues 1 hypothecated share of GM stock. GM prints one new share of genuine GM stock and uses it to buy the hypothecated share. GM's assets rise by the hypothecated share, while its liabilities rise by the genuine share. The value of GM stock is unaffected, since GM's assets rose in step with GM's liabilities--even though the new share of GM stock was backed by something that was, itself, deniminated in shares of GM stock.

  Published: January 2, 2008 1:36 PM

• Don Lloyd

  Moke,

  (2) financial convertibility, where the Fed buys back its dollars with its bonds. The dollar is not physically convertible, but it is financially convertible, as long as the Fed conducts ordinary open market operations.

  Who cares?

  If I have a Federal Reserve Note and treat it as money, holding it in the expectation that it will prove valuable in some future exchange, it IS money, not a claim on money or anything else. This is true whether or not it is legal tender. The bank has no privileged position relative to my FRN over any other potential exchange counterparty. I have no right to think that I can predict exactly, or even approximately, what the future exchange value of my FRN may turn out to be, as the number and variety of causal factors determining it is unlimited.

  Regards, Don
  

  Published: January 2, 2008 3:07 PM

• Person

  Mike_Sproul: You make very good points about Federal Reserve Notes. However, I wish you would referring to the Fed's dollars as "liabilities". Because the dollars do not legally obligate the Fed to do anything whatsoever, they cannot properly be called liabilities in the sense that a bond or a share of stock is. The Fed simply (credibly) promises to slurp out enough dollars to maintain their value. This is NOT the same thing as dollars being a "liability" to the Fed!

  Published: January 2, 2008 3:19 PM

• Mike Sproul

  Don Lloyd:

  Back when private banks issued paper dollars that were physically convertible (for an ounce of silver, let's say), there would be times when people needed fewer paper dollars than usual (end of Christmas shopping season, end of harvest season, etc.) These were the times when people might take their unwanted paper dollars to the bank to exchange for silver. The bank, which didn't want the hassle of paying out silver, could head off the demand for silver by using its bonds to buy up the unwanted dollars. In this way, the bank maintained the value of a dollar at one ounce, while minimizing the number of times it actually had to pay out silver for dollars. That is why I say that as long as the Fed maintains financial convertibility, physical convertibility is normally irrelevant. This is explained in a paper of mine called "There's No Such Thing as Fiat Money", at the website already referenced above

  www.csun.edu/~hceco008/realbills.htm
  

  Published: January 2, 2008 6:12 PM

• Mike Sproul

  Person:

  Dollars are certainly the Fed's liability in an accounting sense, which is why they appear on the liability side of the Fed's balance sheet. As for "legal obligation", that is a minor point. The Fed, as an institution, makes a credible promise to use its bonds to buy back dollars. I don't really care if there is a policeman standing by, ready to throw Bernanke in jail if he fails to perform. What I care about is the Fed's history of maintaining financial convertibility. Obviously, the Fed was created by Congress, and if enough Congressmen became mad enough, then Congress could force the Fed to perform. But that only raises the question of whether there is a policeman standing by, ready to throw Congressmen in jail.

  Published: January 2, 2008 6:22 PM

• fundamentalist

  The Fed will certainly buy back its paper dollars for bonds if you want, and if you're smart, that's what you'll do. But if you were smart enough to trade in your dollars for gold just a few years ago, you could trade back for a profit several hundred percent. But if you hung on to the dollars, your wealth would have evaporated.

  As for trading dollars for bonds, you're doing nothing but exchanging one piece of paper for another. That the Fed backs paper with paper is supposed to be something special? As Dave Barry wrote, the dollar has lost value against most currencies and major brands of toilet paper. Maybe the dollar would be more sound if the Fed backed it with toilet paper instead of bonds.

  Published: January 2, 2008 7:58 PM

• George Laigle

  Don Lloyd -
  
  If you really mean "I have no RIGHT to think that I can predict exactly, or even approximately what the future exchange value of my FRN may turn out to be --", then you obviously are not running a business where depleted raw material inventory must be replenished/purchased with FRN'S. It sounds as if you don't care what it will buy in the future, and that no one should expect their "dollar" savings to be worth anything. Of course, you may be an individual who is never planning to retire, or is counting on someone else to care for you in your old age. If you ARE planning for your retirement,and storing your savings/investments in FRN's, or in FRN denominated paper assets, I hope it works out for you. (But I freely confess that my expressed hope is faint almost to the point of non existence.)
  
  George

  Published: January 3, 2008 10:02 AM

• lester

  "financial convertibility, where the Fed buys back its dollars with its bonds. The dollar is not physically convertible, but it is financially convertible, as long as the Fed conducts ordinary open market operations."

  are you saying that because you can buy gold with dollars they are backed by gold? what is that worth if an ounce of gold goes up and up in price?

  
  also, I wonder if Mr Bock will get any hostile ron Paul questions. probably

  Published: January 3, 2008 10:03 AM

• Mike Sproul

  "are you saying that because you can buy gold with dollars they are backed by gold?"

  No. Paper dollars are backed by the Fed's assets, including gold and bonds. Dollars don't have to be instantly convertible into gold in order to be backed by the Fed's assets. The fact that dollars are backed by those assets is what makes it possible for us to use dollars to buy goods (including gold) on the open market.

  Published: January 3, 2008 11:06 AM

• fundamentalist

  Mike: "The fact that dollars are backed by those assets is what makes it possible for us to use dollars to buy goods (including gold) on the open market."

  I think you're confusing terminology. When people say the dollar is backed by gold, they mean that a dollar bill will always purchase the same number of ounces of gold. What you mean is that the Fed will exchange gold for dollars at the currently existing exchange rate. They're not the same thing. Even the exchange rate of bonds for dollars changes over time, so dollars aren't backed by bonds, whereas you can exchange dollars for bonds.

  Published: January 3, 2008 12:22 PM

• Mike Sproul

  When I say the dollar is backed by gold and bonds, I mean that the paper dollars issued by the Fed are the Fed's liability, and as such are backed by the Fed's assets--gold and bonds. Similarly, GM stock is backed by the assets of GM. For this reason, I can use GM stock to buy goods (including gold) on the open market. But those goods aren't what backs GM stock. GM's assets are what backs GM stock.

  Published: January 3, 2008 12:30 PM

• fundamentalist

  Mike: "When I say the dollar is backed by gold and bonds, I mean that the paper dollars issued by the Fed are the Fed's liability..."

  I know that. I'm saying you're trying to change the definition of "backing" as it's commonly used. What you mean by it and what most other people mean by it are very different. You shouldn't use the word "backed" because the way you use it is wrong by conventional definition. You should use words like "exchange" or "trade" because the dollar is not backed by anything in the normal meaning of the word.

  Published: January 3, 2008 12:44 PM

• David White

  Mike Sproul:

  "When I say the dollar is backed by gold and bonds, I mean that the paper dollars issued by the Fed are the Fed's liability, and as such are backed by the Fed's assets--gold and bonds."

  That "backing," however, is a mirage. As one of your fellow apologists for the status quo puts it:

  "When others must invest in the United States, they are not the ones with the power; the United States is. To us, it looks far more like the Chinese and Arabs are trapped in a financial system that leaves them few options but to recycle their dollars into the United States. They wind up holding dollars -- or currencies linked to dollars -- and then can speculate by leaving, or they can play it safe by staying."

  http://www.investorsinsight.com/otb_va_print.aspx?EditionID=628)

  But of course they speculate by STAYING as well, since they all know that they're playing musical chairs . . . without the chairs . . . there being no place for ANY of them to sit when the music stops.

  So around and around they (foreign central banks) go, each of them having the ability to stop the music but none of them wanting to be the first to do so.

  Nor do they want to be the last, however, as they know that the Fed has a paltry 8 thousand tons of gold in reserve (if it has any at all: http://www.newswithviews.com/Devvy/kidd279.htm), meaning that once the music stops -- i.e., once one or another central banks bails out of the dollar in an attempt to "go for the gold" -- the trillions of dollars flooding the world financial system will plummet to the tens of thousands per ounce.

  But what else to expect from a financial system that others are "trapped in"?

  Makes me think of the tiger that recently escaped the San Francisco Zoo.

  Published: January 3, 2008 2:04 PM

• jp

  The unwinding of a company is a good way to understand what "backs" a bond or a stock. The government gets a first lien on the unwound company's assets, allowing it to recover unpayed taxes. The bond holders get first whack at the rest, and the shareholders get what is left over after the bond holders are satisfied, which in some cases is nothing. It is the firm's remaining assets that back bonds and shares.

  The fine print of any Federal Reserve annual report says "in the event that collateral is insufficient [to cover notes issued], the Federal Reserve Act provides that Federal Reserve notes become a first and paramount lien on all the assets of the Reserve Banks." This means that, in the event of a Federal Reserve windup, FRN holders have seniority to all Fed assets over and above shareholders, government, & unpaid suppliers and employee pension claimants. So given the above windup example, not only are notes a liability of the Fed, they are a very well-backed liability, as Mike has already said.

  Published: January 3, 2008 2:30 PM

• Mike Sproul

  "You should use words like "exchange" or "trade" because the dollar is not backed by anything in the normal meaning of the word."

  I'm saying the paper dollar IS backed in the normal sense of the word. JP put it better than I did. Granted, the mainstream view is that the dollar is not backed. Every econ textbook that I know of says that since the Fed won't give you gold for your paper dollar, then the dollar is unbacked. That's the view I'm arguing against. (Which makes me wonder what got David White thinking I'm an apologist for the Status quo) The fact that the dollar is not physically convertible into gold on demand does not mean that the paper dollar is not backed by the assets of the Fed.
  One way to think of this is to imagine some new kind of credit card that makes people decide to hold no paper dollars at all. As paper dollars pile up in bank vaults, the Fed's normal reaction would be to use its bonds to buy back those paper dollars and retire them. If, after the Fed's bonds have all been sold, there were any paper dollars left to be retired (unlikely), the Fed could buy the rest of the paper dollars with its gold. The Fed can only do this because it holds gold and bonds as BACKING for the paper dollars it has issued. Obviously, if the fed had no assets, it could not buy back the dollars, and the dollars would lose all value, rather than simply being retired when they were no longer wanted.

  Published: January 3, 2008 3:01 PM

• Person

  "The fine print of any Federal Reserve annual report says "in the event that collateral is insufficient [to cover notes issued], the Federal Reserve Act provides that Federal Reserve notes become a first and paramount lien on all the assets of the Reserve Banks." This means that, in the event of a Federal Reserve windup, FRN holders have seniority to all Fed assets over and above shareholders, government, & unpaid suppliers and employee pension claimants."

  Whoa! Sweet!!!!

  Unfortunately, most of its assets are in government bonds, which would probably be worthless (not to mention meaningless) in the event of such an unwinding.

  I call dibs on the Dallas Fed's Wii!!!

  Published: January 3, 2008 3:05 PM