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Inflation & the fate of paper money

Inflation was one of the key themes in our post on Marc Faber's recent CNBC appearance. I said then that we'd talk a bit more about inflation and money creation later in the week. So let's talk about it now.

Have you ever wondered how the fiat money we use comes into existence? We'll you're about to find out.

Last week, Bear Mountain Bull pointed us to a very revealing passage on central bank money creation from Richard Russell's daily remarks.

Here is an excerpt from those remarks; get ready for some truth.

"If the American people ever realized or understood how the Fed operates and how money is created in the US, there would probably be a ten million man and woman march on Washington and more specifically a march on the Federal Reserve Building. The Fed is a private banking monopoly that has "grabbed hold" of the money-creation of the United States. Who controls a nation's money, controls that nation.

The US needs money to pay for building roads, for buying war planes, for fighting wars, for paying Congressmen, for paying IRS and Post Office employees, for a thousand different items. For this the government turns to the tax payers or it turns to the Federal Reserve. The Fed is nothing more than a group of private banks that charge interest on money that never existed before.

How does the system of money creation work? A simplified but true explanation. The government needs ten billion dollars (aside from what it takes in income taxes or from what it borrows). So the government then prints ten billion dollars worth of interest-bearing US government bonds. Next, it takes the bonds to the Fed. The Fed accepts the bonds, and then places ten billion dollars in a checking account. The US government then writes checks to the tune of ten billion dollars against their checking account. But where was that ten billion dollars before the Fed issued the money? The money didn't exist. Can you believe it, the money was created by the Fed "out of thin air."

Now you know how the whole scam works. Kudos to Russell for that explanation, it happens to be one of the most easily understood summaries I've heard or read on the subject.

And by the way, if you ever want to know how inflation has affected the price levels here in the US over much of the 20th century, just ask Richard Russell. He'll tell you about growing up in New York City in the 1930s and '40s, back when subway rides were a nickel, fresh oysters were fifty cents for a dozen, and a New York townhouse could be had for several thousand dollars (for those few who actually had the money).

The big picture theme here is paper money's gradual loss of purchasing power. As he noted back in 2005, the dollar that the Air Force paid him in 1945 buys less than ten cents worth of goods today.

Russell, an "old timer", likes to remind his readers that the one thing you'll never hear a central banker talk about is the purchasing power of a fiat (paper) currency over time.

Why? Because paper money and central bank credit can be created at will; therefore it has no intrinsic value. As more "money" and credit is created over time, the purchasing power of any paper currency will erode, until it eventually becomes worthless.

Which leads me to exhibit B in our discussion of inflation and paper money. For a fascinating look at the average lifespan and history of the world's paper currencies, please see Mike Hewitt's article, "The Fate of Paper Money".

You'll probably want to save Mike's article for future reference, and I hope you'll find it as interesting as I did. Remember to share the knowledge and pass it along!

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