Monitory System of United States of America - Literature review Example

Monitory System of United s of America Introduction Throughout the colonial period, there were coins from various European countries that were used and circulated around these colonies. Spanish coins were in fact used as the dominate currency, but because of the shortage of coins, the trade and commerce was done through bartering and trade in exchange of commodities such as tobacco, rice, rum, and animal skins which were used as money. Paper notes were issued by some colonies but due to the various discounts that were made on them, they were considered almost worthless and unacceptable for trade or commerce. Today, the world’s main reserve currency, which is used for buying and selling resources, energy, other sorts of international trade, and is also the purchasing power for corporations, international institutions, and governments, is the United States dollar (McDaniel, 2008). However, the American Founding Fathers had originally intended to make a monetary system which is very different from what it is now. They had thought of preventing the economic and fiscal problems that the current monetary system is afflicted with. Before America’s independence, the disparate colonies struggled economically with material financial hang-up as there was not enough money that could go around. The colonial governments made attempts to solve the problem by using nails, tobacco, and animal pelts as currency and assigned them as an amount of pennies or shillings so they could affiliate with the existing system. Eventually, the value of these alternative currencies fell. The colonies kept trying with paper, coinage, and other methods as they were forced to retry since they owed money to the crown but didn’t have any currency to repay with (Friedman, 2008). The local government called the paper money ‘bills of credit’ and they told the people ‘here just use this. It’s real money. We’ll sort out redeemability later.’ There were several debates to address the fact whether paper was real money or just a medium which was going to end badly. This dispute between the advantages of national currency and the fear of paper raged in the United States for more than a century and it was even in the front and center of the Constitution (Harris, 2002). After the Civil War and the economic fallout, the paper issues by the federal government got its chance. By the end of the war, there was inflation and the attention to the problem of constitutionality of paper money was raised again. Salmon P. Chase was the secretary of the Treasury Department who first made the greenbacks possible. Then he became the Supreme Court justice in less than a decade and made a historic ruling that currency notes were rather illegal. This determination was made despite the fact that his face was printed on those notes. The Supreme Court reshuffled and new justices were appointed on the same day when the initial verdict was given against the paper money so the ruling could be revered quickly. The decision was made that the constitution may not explicitly grant the federal government power to issue the bills of credit, but it had the implicit right to do so because governing over this country would be totally impossible without it. There was still not a single national currency circulating as thousands of private banks issued their own notes which were backed by coinage or bullion in a safe, but often backed by nothing at all (Walton, 2013). This became a monetary free-for-all and despite the universal acceptability of the greenbacks, it was strange to believe that about a century ago money in U.S was a smorgasbord. There were countless types of paper money which circulated across the country much of which had unstable value and questionable authenticity. During the chaotic time, it was understood that the value of paper will be dependent on the ability for it to be exchanged with gold or silver. The fact that precious metals are incarnated with value was still as strong as it was 2,000 years before and decades later to this day. It was unimaginable that currency had value without linking to metals. The currency which wasn’t associated with metals was considered to be fluid (Walton, 2013). In 1933, the first step was taken by President Franklin Roosevelt who called in the gold supply of the public in an effort to rebuild the economy at the time of the Great Depression. In 1944, the representatives from the major economies of the world anointed the American dollar to be the de facto currency of the globe replacing gold. The dollar would still be exchanged on a value of $35 an ounce to gold. The agreement gave all the other countries the right to get their stashes of dollars exchanged for gold. This policy was rarely acted upon but by 1970s, it had become an obvious absurdity as the foreign banks held dollars which were equal to three times the amount of gold that America owned. This situation provoked the foreign governments because a deficit or war would weaken the U.S economy and would hurt the dollar. And weakening the dollar would mean that other countries’ economies and currencies would be dragged down as well (Friedman, 2008). The dollar remained as the world’s anchor currency and it was that one ring that ruled everyone. Governments held on to the dollars and used them to pay their debts and still most of the items are priced in American dollars. Commentators in U.S still proudly declare the dollar being the most stable currency of the world as if it was their economic policies. In reality, this is the result of the negotiations and efforts that were made generations ago on which the American economy is standing today (Norton, 2011). Today, U.S has managed a monetary system which is no longer based on metals. The Federal Reserve has initiated and carried out a monetary policy that has stabilized the growth rate in money supply which influences the economy and controls the inflation rates. The U.S monetary system has the flexibility to fulfill the needs of the general public and to stimulate the economy whenever stimulation is supposed necessary. The Federal Reserve System is the central bank of America which is the most powerful actor in the U.S. economy and the whole world. The Federal Reserve was initiated in the 1913 by the Congress. The functions of the Federal Reserve System are to control inflation, prevent triggering recession, supervising the banking system of the nation to protect consumers, maintaining the stability of the financial markets and constraining potential crises, and acting as the central bank for all other banks, foreign banks, and the U.S Government. The Federal Reserve System has four major components which are the Board of Governors, the Federal Open Market Committee, the twelve regional Federal Reserve Banks, and the member banks throughout the country (Walton, 2013). The Board of Governors consists of seven members and is a federal agency which is responsible for overseeing the 12 District Reserve Banks and to set the national monetary policy. It also regulates and supervises the banking system of the U.S in general. Governors are appointed for a term of 14 years staggered. The Federal Open Market Committee has 12 members from which seven are from Board of Governors and 5 are the presidents of the regional Federal Reserve Bank. The committee oversees the open market operations which is the principle tool for national monetary policy. The committee directs the operations which are undertaken by Federal Reserve in foreign exchange markets (McDaniel, 2008). The third component is the 12 regional Federal Reserve Banks which are responsible for all the member banks which are located in the district. These banks supervise the commercial banks and tend to implement monetary policy. Lastly, the member banks are the commercial banks which are majorly a part of the U.S Federal Reserve System. National banks are definite members but state chartered banks may join under certain requirements (Harris, 2002). The U.S dollar’s value is measured easily by the exchange rate which compares the value to other currencies. Currency exchange rates determine the value of one currency against the other. These rates change every day as currencies are traded in foreign exchange market which is known as forex. The forex value of a currency depends on many factors including interest rates of central bank, the debt levels of the country, and the economic strength. When these factors are strong, the country’s value of currency is also strong (Norton, 2011). The U.S dollar has ruled over the world for decades being the strongest of the world’s currency. It was ever since the 1930s when 35 U.S dollars were worth the value of one ounce of gold. After WWII, there were many other countries as well which based their currency values on the U.S dollar. Unfortunately, the U.S dollar eventually suffered from inflation and lost its value in gold but the other currencies of the world became more stable and valuable. The U.S could not pretend the worth of the dollar so officially they reduced the value from $35 for once ounce to $70. The value of the dollar was cut in half (McDaniel, 2008). Then the U.S took away the standards of gold altogether in 1971. Now the dollar didn’t represent any amount of gold or any precious metal but its value was now determined by the market forces alone. The U.S dollar then dominated the financial markets largely and even today the exchange rates are expressed in terms of the U.S dollar. The U.S dollar along with the euro account for 50% of all currency exchange transactions taking place in the world. Inflation of the money supply has been a problem in the U.S monetary system and one source of inflation is the Federal Reserve. The inflationary process initiates when the government wants to spend money so that the government issues securities against the existing money. The Federal Reserve has the ability to purchase the securities of the government with their money. Another source of inflation is the fractional reserve banking practice. This practice allows banks to lend money that is multiple times more than in the reserve. Banks inflate the money supply by giving out loans which aren’t backed by the reserves (Norton, 2011). Theoretically, the inflation caused by the Federal Reserve and the banks can be reversed when the loans are paid back. This doesn’t happen in reality and instead the money supply is continuously inflated as new money is loaned faster than the previous loans are paid back. There are no physical limits applied on the inflation of money supply which is why excessive government spending and debt are enabled. Currently, the monetary system of the U.S has totally destroyed the economy. The president’s economic recovery policy has been a complete bust since unemployment rates are high, the economy is hardly growing, and there is inequality greater than any time in the history. The inflation rate has dropped to 1.2 percent and the private sector hiring is a major disappointment. The emergency program of the Federal Reserve has been unsuccessful and the policymakers are making no good efforts. Thus, this situation of the U.S economy and monetary system has already led many foreign investors to take their investment out of America and invest them in stronger and emerging economies such as China (McDaniel, 2008). It is also true that the dollar tends to remain the most popular reserve currency of the world. The share it has on the total reserves may decline but the total number of dollars held by foreign countries will rise continually. This will keep the interest rates lower than they would have been otherwise but it won’t prevent the interest rates from rising in the global market (McDaniel, 2008). Thus, the U.S monetary system had started off with efforts and struggles of the colonies and government to make the currency stable and valuable. With centuries of efforts, dollar had become the most stable currency of the world and had continued to dominate the world economy for years. However, recently there have been certain factors which have led the value of dollar to decrease which has affected the overall economy as well as the interest of investors in the country’s economy. References Friedman, M. (2008). A Monetary History of the United States. Princeton University Press Harris, S. (2002). American Economic History. NJ: Beard Books McDaniel, C. (2008). The Future of Business: The Essentials. London: Cengage Learning Norton, E. (2011). Introduction to Finance: Markets, Investments, and Financial Management. NY: John Wiley & Sons Walton, G. (2013). History of the American Economy. London: Cengage Learning Read More