Chapter 2 – What Is a Dollar or Federal Reserve Note, and What Backs Our Money?
Available on Amazon: https://www.amazon.com/Illusions-Wealth-Actively-Investments-Volatile/dp/0982586167
If you were to ask 10 people this question, you will get 10 different answers as to what a dollar or Federal Reserve Note really is and what backs it. Some of the hardcore Constitutionalists will say it is a certain weight of silver. But most will agree that a dollar is that piece of paper in your wallet, otherwise known as a Federal Reserve Note.
If you were to type into Google; “What backs the U.S. Dollar?” Google in their infinite wisdom has picked an article I wrote as the answer (Google knows everything right? 😊)
I pointed out that the place to find part of the answer to this question of what backs the U.S. Dollar comes directly from the Department of the Treasury website:
Federal Reserve notes are not redeemable in gold, silver or any other commodity, and receive no backing by anything. This has been the case since 1933. The notes have no value for themselves, but for what they will buy. In another sense, because they are legal tender, Federal Reserve notes are “backed” by all the goods and services in the economy.[1]
What they are essentially saying is that our economy or GDP is what backs our money. If this is true, then we need to analyze what’s going on in the economy to get an idea of how strong the dollar is, which is what we will do in Chapter 5 as it needs an entire chapter to explain the process.
For now, you pull dollar bills out of your wallet, you buy things, you check your accounts and you see you have money and you go about your day with complete trust your money will be there tomorrow. But did you know that your money has changed over time? Do you know what really backed your money a century ago versus today?
It has been traditional for bankers and other private managers of money to cloak the working of the money system with the mantle of secrecy. And many of our high public officials share this view. Although they are appointed to represent the public interest they seem to feel that it would be somehow dangerous to talk about the monetary system in ways that let the public understand who does what, and why. (“A Primer On Money.”)
I really need you to read that paragraph again. It fits in 100% to the theory I have presented as to why we are never taught anything about our monetary system. But before I become more enraged on this issue, as you will eventually be, let’s look at some basic information on our money first.
Federal Reserve Notes (what we in America refer to as dollars) come in denominations of $1, $2, $5, $10, $20, $50 and $100 bills. In the past we have also had $500, $1,000, $5,000 and the non-circulated $100,000 bill. While you might be able to say you know which president is pictured on each of these notes, the odds of you knowing the text written above and below those presidential portraits and how those words have changed over time are probably quite slim. Pull out any bill now and follow along.
Gold Certificates
The $10 bill that was in existence after the Federal Reserve was created in 1913, and through 1933, was called a Gold Certificate, and had the following inscribed:
“This Certificate is a legal tender in the amount thereof in payment of all debts and dues public and private” on the left side of the bill. At the top it states; “This certifies that there have been deposited in the treasury of the United States of America and at the bottom it continues; Ten Dollars in gold coin payable to the bearer on demand.”
You could take this piece of paper to any bank and get a $10 gold coin in return. Or you could take your $10 gold coin to the bank and get a $10 gold certificate.
You’ll recall above our story of the goldsmith’s almost 200 years earlier and how that turned out. What do you think happens next?
Legal Tender and Confiscation
You see with this $10 gold certificate an introduction of the words “legal tender.” What is legal tender? Legal tender is money that the U.S. government declares usable for payment of taxes and debt, both public and private.
By the time 1933 rolled around, there had been a run on the banks and people were rushing to either exchange their paper money for real gold or simply withdraw their money, as they didn’t trust the banks holding onto it. President Franklin D. Roosevelt had to do something to stop the bank depositors from exchanging their bills for gold or withdrawing it and declared a bank holiday, as over 10,000 banks had failed. He then passed Executive Order 6102 to have the citizens turn in their gold coins in exchange for equivalent bills, mostly $10 and $20 to correlate to the most popular $10 Eagle and $20 Double Eagle gold coins in existence at that time. It is of note that Roosevelt did this without authorization from Congress, and the money used to buy all the gold from citizens was created through the Federal Reserve and the U.S. Mint out of thin air. Remember, the Federal Reserve at this time was only in existence for 20 years.
In 1934, upon getting all the gold from the fine citizens of the United States—who simply did what their government told them to do and turned it in—FDR raised the value of gold from $20.67 an ounce to $35 an ounce. By default, everyone who received those newly printed Federal Reserve Notes saw their purchasing power compared to gold decrease by 75%, which was a huge windfall for the U.S. government.
In essence, by decree, these bankers didn’t make the same mistake goldsmith’s did because they intertwined government and the monetary system with the Federal Reserve. The Federal Reserve we will get into at a later time, but for our understanding now, just know that it is not part of the government but works with the government by loaning it money they create out of thin air for a payment of interest back to them.
At the same time of the confiscation of gold, what was printed below the portrait of the president on the 1934 Federal Reserve Note changed, too.
The new notes now said this:
“This note is legal tender for all debts, public and private, and is redeemable in lawful money at the United States Treasury, or at any Federal Reserve Bank”
and
“Will pay to the bearer on demand ten dollars.”
The note was still legal tender, yet was no longer redeemable in gold coin,[2] but instead “lawful money,” which most citizens presumed of course to be gold, even though they couldn’t exchange the bills for gold. But governments still traded currency for gold amongst themselves.
Notice one thing that the Federal Reserve says these Federal Reserve Notes can be redeemed. They say they can be taken to the Treasury Department of the United States, in the city of Washington, District of Columbia, or any Federal Reserve bank.” Instead of gold, silver or any other commodity, they go on to say that the “Federal Reserve Banks must hold collateral equal in value to the Federal Reserve notes that the Federal Reserve has in circulation, chiefly held in the form of U.S. Treasury, federal agency, and government-sponsored enterprise securities.” You’ll find out in the Federal Reserve Section this collateral on the Fed’s balance sheet has changed since the 2008/2009 financial crisis because of unprecedented moves by the Fed and this means this “collateral” is now something else than what it was, and it’s not looking pretty for the Fed, especially should another recession or worse come into play. You’ll be able to judge for yourself whether this is likely after finishing these 4 sections, the educational foundation awareness needed for maintaining and growing your wealth.
The Federal Reserve Notes didn’t change again until President Richard M. Nixon, due to demands by foreign countries to exchange Federal Reserve Notes for U.S. gold, saw that some countries were trying to redeem their notes for physical gold by asking for delivery of the gold. This didn’t sit well with the Fed as without the illusion that gold was backing dollars at the time they couldn’t continue their monetary schemes that essentially always protect themselves as they did in 1933 when the government confiscated gold and bailed the Fed out. That snipped above from the Federal Reserve website was written well after the Nixon ending gold payments to settle debt. The Fed had purged gold from the system and in answering that FAQ changed the language from gold and silver backing to treasuries and other government debt. They are a sneaky bunch of thieves.
There were simply too many dollars floating around in 1971 (again, back to the goldsmith’s example 240 years earlier) and the chickens (paper dollars) were coming home to roost back here in America with the requests by other nations for payment in gold. Nixon had a choice: Give away all our gold, or just say no to the redemption requests. Nixon closed the gold exchange window completely in 1971.
The Federal Reserve Notes you hold in your wallet since 1971 were changed to now simply say:
“This note is legal tender for all debts, public and private” and “Ten Dollars.”
These new notes didn’t even say they were redeemable in dollars any longer! But they kept the words “legal tender.” They also got rid of the words “lawful money.”
What Is a Dollar Today?
In addition to all the issues mentioned in this chapter, there is one more aspect to the dollar that most in the investment world don’t understand, but you need to. This is also not taught in schools, and the majority of people in the financial world are clueless about it. The dollar is a representation of 6 currencies, the Euro, Yen, Pound, Canadian Dollar, Krona and Franc.
Whatever these currencies do, the dollar will do the opposite. The Dollar Index is heavily weighted towards the Euro (57.6%). For the most part, whatever the Euro does, the dollar will more than likely do the reverse. Dollar up, Euro down and vice versa.
Next up is a long-term chart of the Dollar Index. You will see a number that coordinates with the index. Presently it is 99.01. This is the number that represents that basket of currencies in the preceding table and shows you the overall strength or weakness the dollar has when priced in all of these other currencies.
We hear terms like “strong” and “weak” dollar, but many don’t know how volatile the dollar really is over time. It’s really not the steady investment many think it is, because at times it buys more things and other times less things, as the following chart shows.[3] In and of itself, the dollar loses purchasing power over time. To understand this last sentence in a nutshell, and we’ll go into this in more detail later, but a 1964 quarter that has 90% silver in it can almost always buy about a gallon of gas as it did then. A 1965 quarter could also buy about a gallon of gas and today, that same quarter which is “legal tender” can buy you 25 cents of gas. One has always kept pace with inflation and bought you a gallon of gas. The other is government influenced and will always buy you less and less gas over time. This is what the government has done to our money.
In 2017 the dollar got up to 102 and fell by 2018 down to 89, a -12% drop. Does the dollar look stable to you? You’ll find out in a bit that a Nobel prize winning economist refers to this as a “risk free” asset. Nothing could be further from the truth as you see.
What’s ironic is that you never see this Dollar Index figure on CNBC, Bloomberg or Fox Business Channel. You only see the euro/dollar, yen/dollar, and pound/dollar figures that most investors watching these shows—let alone the public in general—don’t even understand the meaning of.
For example, CNBC will show the euro/dollar figure (1 euro=x dollars) and the pound/dollar figure (1 pound=x dollars) but in quoting prices for the Japanese currency, they reverse the equation to dollar/yen (1 yen=x dollars).
Don’t you find it rather peculiar that the financial media don’t tell Americans daily how the one asset our entire financial system is based on is doing overall, but just show its relationship to a few other currencies even though most people have no idea what it really means?
We can clearly see from the chart that at times our dollar has been weak versus these six currencies, and sometimes stronger. This strength or weakness has underlying factors we’ll discuss in the Economics section but also touch on Federal Reserve policy that influences interest rates and what the Fed does to affect the dollar too.
As an investor, you need to know this, as it helps you position your portfolio to protect it against any potential dollar decline. But the real issue isn’t in showing you dollar weakness or strength. It’s the fact that all currencies being priced in each other is an illusion because over time it takes more of every currency to buy things than it did 5, 10 or 20 years ago. Remember the 1965 quarter example and it’s the same in every country from then to now as inflation eats away at all currencies as government debt grows bigger and bigger everywhere.
If you have the dollar on one side of a ship, and all these other currencies on the other side, and they run from one side of the ship to the opposite when priced in each other, what difference does that make when the entire currency ship is sinking? That’s what inflation is, and it destroys a currency over time. Ask any senior and they know their Social Security check doesn’t buy what it used to.
How do these currencies maintain purchasing power over time? This is what most economists, gurus, financial planners and Congress don’t understand. It’s the dirty little secret that no one wants anyone to discuss, and it’s not conspiracy. Economist John Maynard Keynes spelled it out for all to see in 1919 in his book, The Economic Consequences of the Peace, just six years after the Federal Reserve was created:
Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some… Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose. [4]
You never hear the regular media talk about the dollar either, as they bombard you with the latest Hollywood gossip, news stories on racial divide or some murder case and naturally the President. That is at least until the next war breaks out.
You’ll hear a few-second clip on what stocks or bonds did that day and maybe a story about a company that did something wrong—and that’s the extent of nightly national coverage on investing. This leaves the few—and I truly mean few—of you, meaning the ones who actually bought this book, research the internet, buy books and magazines, and watch documentaries, to find the truth.
This isn’t even discussed in the Certified Financial Planners (CFP) books and it certainly isn’t taught in the training an advisor sits through to get their licenses from the SEC and NASD who rely on outdated data and faith in a system that is clearly flawed.
The three questions I propose you ponder at this point:
- How much lower can the purchasing power of the dollar and other currencies get?
- Who will tell me whether this can possibly get worse?
- What can I do to protect the purchasing power of my portfolio?
These questions will be answered in this book, but first let’s look at a brief history of coins in America, and further reveal what the government has done to our money. Coins, just like dollars, have changed over time.
U.S. Coinage
While Federal Reserve Notes have changed over time, so too has the coinage of America. We already know that gold coins were used until 1934, but silver, copper and nickel were also used as money. Pennies were made of 95% copper; nickels of copper and 25% nickel. And dimes and quarters were 90% silver.
This all changed in 1964, when they stopped minting 90% silver dimes and quarters and replaced them with coins made up of 91.67% copper and 8.33% nickel.
The mostly copper pennies were replaced with 97.5% zinc and now contain only 2.5% copper (Pennies made prior to 1982 are worth over double today in melt value.)
Coins today don’t even sound like money used to. There’s no ping sound, just a dud sound when it hits the ground.
Money should have the characteristic of possessing a store of value.
Investopedia explains store of value:
Possessing a store of value is an underlying basis for any economic system, as some medium is necessary for a store of value in order for individuals to engage in the exchange of goods and services. As long as a currency is relatively stable in its value, money (such as a dollar bill) is the most common and efficient store of value found in an economy.[5]
But does Investopedia have it correct? Are coins a good store of value?
As I already alluded to, in 2018, the same 1964 quarter with 90% silver mentioned earlier, exchanged for the scrip of the day (dollars), can buy you a gallon of gas. Guess what a 1965 quarter can buy you? You’re right, 25 cents worth of gas.
While it is illegal to melt U.S. coins, it seems that some are doing this—upsetting U.S. Mint director Ed Moy, who said this could lead to shortages: “The nation needs its coinage for commerce,” he said in a statement. “We don’t want to see our pennies and nickels melted down so a few individuals can take advantage of the American taxpayer.”[6]
Thy silver is become dross, thy wine mixed with water—Isaiah 1:22
I find amusing claims that citizens taking current U.S. coins and melting them down would be taking advantage of American taxpayers, but hasn’t the government been taking advantage of taxpayers by debasing the coins to begin with? Isn’t it ironic how the tables have turned on the government, just by playing their own game? But even the government’s own Bureau of Engraving knew what the key ingredient in the monetary system was and still is today: “the public’s willingness to accept it.”
The Bureau prints approximately sixteen million notes each day. The Bureau has the power to create money and almost any amount of it. The only limiting factors are the speed of the presses, and the public’s willingness to accept it—Government Securities, U.S. Bureau of Engraving
What really puts this government action of debasement into perspective is the fact that our government still values the gold we possess in Fort Knox at $42.22 an ounce.[7]
Why in the world would they do that? In 1985, the U.S. government passed the Gold Bullion Coin Act, which for the first time authorized the U.S. Mint to create a gold coin called the American Eagle. What is the dollar amount they stamped on the one-ounce gold coin? The answer is $50. They did so knowing full well that the actual spot price of gold at the time was $322.25 per ounce.
These geniuses did one other peculiar thing in pricing the gold Eagle coins. They also came out with a ½-ounce coin with a face value of $25; a ¼-ounce coin with a face value of $10; and a 1/10-ounce coin with a face value of $5. Anyone notice what’s wrong with the math here? Four of the ¼ ounce coins total $40 in value according to the government’s math. They should have $12.50 stamped on them, not $10. You simply can’t make this stuff up!
Pictures of the set of eagles here. Chris.
Does a Coinless Society Make Sense?
This is the point in time where I actually propose something I think makes sense. We already know that the government continually debases the value of coins and this leads to the question, “Are coins even needed now?” Please note that I am not advocating a cashless society here, but coins aren’t silver or gold any longer, and thus have no real intrinsic value.
It may be hard to imagine doing away with coins, but the truth is that coins should be outlawed in the U.S. The days of getting Bazooka Joe gum for a penny or a candy bar for under $1 are long gone. The days are also gone taking your collected coins to Vegas and throwing them in a slot machine.
What do you do with your change when you accumulate so much of it? Do you wrap it up in sleeves and take it to the bank? How much time does it take to count, wrap and transport them? How much is your time worth per hour? Or are you one of those who are strapped for time, and just head to the grocery store’s coin-counting machines and pay 5% to 10% to cash in? Do you like losing 10% on your money?
There’s just no real use for coinage anymore because it doesn’t represent what it did when coins held their value. Whether it’s pennies, nickels, dimes, or quarters, they all don’t buy what they used to, so why bother with them? Why hold on to something when the government keeps changing its true value? The time you wait for change, the money retail corporations pay their employees per hour to count change, it just doesn’t add up to productivity. It’s actually a detriment to society this day and age. A penny saved doesn’t even earn you anything any longer. Then the government taxes you for saving it.
Money Today Is Simply Debt
One thing you should understand about money in general is that it’s debt. In a sense, it is a promissory note that someone else must eventually accept for you to acquire what you need. At some point, entities may decide to no longer accept that note. While the U.S. is far from such a situation, we have seen these notes (or money) rejected throughout the history of mankind from the German mark of WWI (which had lasted 53 years), the Argentine peso of 1983, 1985 and 1992, the Zimbabwe dollar of 2006 (pictured), the Peruvian sol of 1985 that had endured for 122 years, and the 170-year-old Mexico silver peso.
Zimbabwe 100 trillion-dollar note
I bought 300 of the 100 trillion Zimbabwe notes on eBay when I heard they stopped printing them after becoming worthless in Zimbabwe, because I figured they might become a collector’s item. I paid $1 each for them and sold them a few years later for $10 each. They are worth much more now and I regret selling. I have seen them for over $100 on Ebay. But you should know this is the exception to the rule on worthless money—we had never seen a 100 trillion note before.
The amazing aspect to all currencies is the average lifespan is 37 years. Let that sink in for a second. Most people reading this book will have lived through half the world’s currencies going under at one point or another.
The U.S. dollar in its current form was first created in 1913, but since Nixon took us off the gold standard in 1971, this new version of the Federal Reserve Note that has been around only 47 years in 2018 does one thing: accumulate more debt to back it. What does more debt eventually do to a currency? It erodes the trust in it. Therefore, you need some protection or insurance for your portfolio, whether or not the currency fails. Whether it be paper money, plastic money like credit cards or digital money like crypto currencies which we’ll address later, it’s all faith based and there is a matter of trust involved.[8]
Are We Moving to a Cashless Society?
In 1934, just after the government had confiscated the gold and handed out Federal Reserve Notes that they immediately devalued, the board game Monopoly from Parker Brothers (now Hasbro) came out. What most don’t know about this game is one of the rules actually states; The Bank never “goes broke.” If the Bank runs out of money, the Banker may issue as much more as may be needed by writing on any ordinary paper.[9]
This is what the Federal Reserve does, through the U.S. Mint and with the blessing of congress. They get into trouble, they get bailed out. Their latest scheme we’ll address is they actually bought assets of troubled institutions. How? Where did this money come from? Or, if you remember their definitions, where did this collateral come from?
It is no secret that gold has been the enemy of the fiat printers of money and they have done a good job of eliminating gold’s connection as money over the years. Now it seems that some want to do away with some of our cash that we carry around like the $100 bill.
Former treasury secretary and Harvard professor Lawrence H. Summers wants to do away with high-denomination bills completely,[10] in the best interests of ordinary citizens he tells us—because of the link to crimes, primarily drugs and terrorism). Perhaps the government should stay out of funding drug running[11] and terrorism,[12] themselves as a start?
As a child you may have got used to the game Monopoly and using your Monopoly money, which many have compared to Federal Reserve Notes, as your way to buy real estate like Boardwalk or Park Place. Did you know that they have come out with a version of the Monopoly game that is cashless? It is called the Ultimate Banking edition and it does all the arithmetic for the players. But Monopoly is behind the times as many countries around the world are already becoming cashless.
These are the leaders in cashless consumer spending, and their percentage of financial transactions. We’re already getting there in the U.S. and most don’t even know it.
Belgium 93%
France 92%
Canada 90%
United Kingdom 89%
Sweden 89%
Australia 86%
Netherlands 85%
United States 80%
New World Currency
There is always talk of a new currency that may surface to replace the dollar. For example, in recent history, some thought the U.S., Canada and Mexico would band together and create a currency that would compete better with the euro called the Amero. This was just a silly rumor. You will find out later in this book that the euro is having problems with some countries (like Greece, Spain and Italy) threatening its strength. It doesn’t make sense for Canada or the U.S. to take on a country with a history of monetary failure and corruption, like Mexico (no offense to anyone here, but just talking monetary economics). This simply won’t happen.
As for anyone else replacing U.S. dollar as reserve currency, if they could, they would. China, for instance, has no credible bond infrastructure, lacks transparency, refuses to join the free-float foreign exchange market, and has the most overleveraged banking system in the world. The yuan does not have the capacity or credibility to become a reserve currency. At least not yet, but it is now included in the IMF’s Strategic Drawing Rights basket (SDRs).
There are also rumors that at some point we may have a one-world currency. The speculation is that it would be run by the IMF via their SDRs, or possibly be a basket of the well-known producing economies of the world. Some say a new world currency might be backed by gold and come from China. Mike Maloney, of Rich Dad, Poor Dad fame, says that the “change to a new monetary system is inevitable.”[13] Jim Rickards constantly floats the idea that SDR’s will take over as the world reserve currency which I debunked with an article;
“The Fear Mongering Crowd – Dollar Death On September 30th Edition – SDRs.” https://seekingalpha.com/article/4007197-fear-mongering-crowd-dollar-death-september-30th-edition-sdrs
I disagree with these two. A new world currency makes no sense as it would automatically put countries that have weak economies at par with countries that have strong economies. If one country wanted to go to war with another, it would need to somehow fund the war and get permission from the printers of the currency to do so. Who would give up their sovereignty to another entity or group of individuals that control the monetary system, especially when they are already a world power? It’s silly to think the U.S. would do this.
For any global currency to come to fruition, the U.S. dollar would have to fail. With the dollar still used by 60% to 70% of the world, this won’t be happening anytime soon, especially when you also have the world’s strongest military presumably backing the dollar too.
Lastly, it is true that all fiat currencies have indeed failed from a historical perspective, but we in the U.S. have shown that the world’s largest economy can afford to have some major debt while at the same time deflecting attention away from calculating how serious of a problem this debt can become when interest rates rise.
[1] http://www.treasury.gov/resource-center/faqs/currency/pages/legal-tender.aspx
[2] http://www.federalreserve.gov/faqs/currency_12770.htm
[3] http://www.fxstreet.com/rates-charts/usdollar-index/
[4] http://www.econlib.org/library/YPDBooks/Keynes/kynsCP6.html
#Chapter 6
[5] http://www.investopedia.com/terms/s/storeofvalue.asp
[6] http://usatoday30.usatoday.com/money/2006-12-14-melting-ban-usat_x.htm
[7] https://www.usmint.gov/about_the_mint/fun_facts/?action=fun_facts13
[8] http://www.rapidtrends.com/history-of-fiat-and-paper-money-failures/
[9] http://www.hasbro.com/common/instruct/monins.pdf
[10] https://www.washingtonpost.com/news/wonk/wp/2016/02/16/its-time-to-kill-the-100-bill/
[11] https://en.wikipedia.org/wiki/Allegations_of_CIA_drug_trafficking
[12] https://en.wikipedia.org/wiki/State-sponsored_terrorism#United_States