How Fiat Money Works + Some Suggestions

Money and the Steady State Economy

... Fiat money came when we dropped any pretense of gold “backing,” and paper tokens were declared to be money by government fiat. Currency is printed by the government at negligible cost of production, unlike gold. As the issuer of fiat money the government makes a profit (called seigniorage) from the difference between the commodity value of the token (nil) and its monetary value ($1, $5, …$100 …depending on the denomination of the paper note). Everyone has to give up a dollar’s worth of goods or services to get a dollar—except for the issuer of the money who gives up practically nothing for a full dollar’s worth of wealth. Nowadays the fractional reserve banking system counts fiat currency instead of gold as reserves against its lending. The demand deposit money created by the private banking sector is a large multiple of the amount of fiat money issued by the government. Who earns the seigniorage on the newly created demand deposits? The private banks in the first instance, but some is competed away to customers in the form of higher interest rates on savings deposits, lower service charges, etc. It is difficult to say just what happens to seigniorage on demand deposits, but clearly that on fiat currency goes to the government. (With commodity money seigniorage is zero because commodity value equals monetary value—except when the mint purposely debased gold coins). Under our present system, money is currency plus demand deposits. Currency is created out of paper by the government, and no interest is charged for it; demand deposits are created by banks out of nothing (up to a large limit set by small reserve requirements) and interest is charged for it. For example, when you take out a mortgage to buy a house, you are not borrowing someone else’s money deposited at the bank. The bank is in fact loaning you money that did not exist before it created a new deposit in your name. When you repay the debt, it in effect destroys the money the bank initially loaned into existence. But over the next 30 years, you will pay back several times what the bank initially loaned you. Although demand deposits are constantly being created and destroyed, at any given time over 90% of our money supply is in the form of demand deposits. ...