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Questions About Economics  
User currently offlineDuke From Canada, joined Sep 1999, 1155 posts, RR: 2
Posted (9 years 9 months 1 week 4 days 21 hours ago) and read 1290 times:

Could someone please explain these questions about economics to me:

1) how do the markets know exactly where a currency stands at any given time? How are these values calculated?

2) how is money created? I understand that governments/national banks print bills and circulate them through banks, but what do the banks give the governments in exchange?

3) I have been told by some of my students who work in banks that a lot of money exists only in theory and that the governments do not create this money but that the economy (I.E. purchase and sale create this money). How is this possible? Is there any way of determining precisely how many Canadian dollars, American dollars, Euros, Czech crowns etc exist?

4) why does printing a lot of money create inflation as a rule? I mean okay, if the government printed money and just handed it out to people, shops would as a rule raise prices, people would probably stop working and there would be chaos, but does it ALWAYS have to work that way? For example, we know of the devaluation and inflation of the Deutsch Mark following WWI, when Germany printed a lot of money to cover its war debt. Why could Germany not just, for example, have printed several limited-edition 1,000,000 mark bills, sent them to the countries it was obligated to indemnify, and gotten on with life? Why did printing money to cover costs for an OVERSEAS transaction affect currency LOCALLY, when that money wasn't used for buying and selling things IN GERMANY? Or did the problem lie in an impossibility to pay the indemnity in cash, meaning that theoretic money had to be transferred to the other governments from the national banks, necessitating printing of big-value notes for use in Germany?

Difficult questions, I know. Anyone major in economics here?

7 replies: All unread, jump to last
 
User currently offlineStarAC17 From Canada, joined Aug 2003, 3410 posts, RR: 9
Reply 1, posted (9 years 9 months 1 week 4 days 19 hours ago) and read 1268 times:

Quoting Duke (Thread starter):
I have been told by some of my students who work in banks that a lot of money exists only in theory and that the governments do not create this money but that the economy (I.E. purchase and sale create this money). How is this possible? Is there any way of determining precisely how many Canadian dollars, American dollars, Euros, Czech crowns etc exist?

This is true in that when you deposit money into the bank they only keep 10% of that money in reserves and then use the rest to lend out to others in loans and mortgages. So for every $10 you deposit $9 is being lent to a guy to buy a house. The bank then receives interest on that guy paying the money back. One of the causes of the great depression was the fact that banks in 1929 didn't have the reserves when people wanted to close out their accounts when the interest rates dropped and therefore it led to bank failures. Something now that government monetary policy prevents.

Quoting Duke (Thread starter):
how is money created? I understand that governments/national banks print bills and circulate them through banks, but what do the banks give the governments in exchange?

Money is relative and is just essentially a unit of trade for example say I had a Boeing 777 which costs about $100 million I could use that as currency and buy 200 $500,000 ferraris for one 777. Cash is a form of money that holds a value internationally. The bank of Canada creates the cash which is say equal to the reserves of the big 5 banks in Canada which are considered when money is printed. As I said above banks have on hand about 10% of all the money invested in the country. Other types of money are debit and cheques which are instructions for the bank to transfer money from one account to another.

Quoting Duke (Thread starter):
why does printing a lot of money create inflation as a rule? I mean okay, if the government printed money and just handed it out to people, shops would as a rule raise prices, people would probably stop working and there would be chaos, but does it ALWAYS have to work that way? For example, we know of the devaluation and inflation of the Deutsch Mark following WWI, when Germany printed a lot of money to cover its war debt. Why could Germany not just, for example, have printed several limited-edition 1,000,000 mark bills, sent them to the countries it was obligated to indemnify, and gotten on with life? Why did printing money to cover costs for an OVERSEAS transaction affect currency LOCALLY,

IT doesn't have to be this way but with an increase of the money supply there is an increase of prices to compensate to reach an equilibrium price which is now how inflation is controlled today.



Engineers Rule The World!!!!!
User currently offlineStevenUhl777 From , joined Dec 1969, posts, RR:
Reply 2, posted (9 years 9 months 1 week 4 days 13 hours ago) and read 1241 times:

I suspect the governance of the monetary supply is similar in Canada as it is in the US and other nations, although each country has its own rules, policies that you would have to research.

There are undergraduate and graduate level classes on monetary policy, micro and macroeconomics, and international economics that would answer your questions in great detail.

After the Depression, in the US, the FDIC was created, which stands for Federal Deposit Insurance Corporation. The US government insures the first $100,000.00 deposited in an account. Additional reforms were passed in the past, especially after the S&L scandal of the late '80s.

As far as currency goes, the highly simplified answer is supply and demand. Economic, social, and political factors also play in to how a currency may be valued at a certain time. Before the Euro, each nation's currency value varied greatly in the worldwide markets, which is a big reason why the EU sought to have one common currency. It started out around 1-1 with the US Dollar, and has risen in value ever since. Institutions and governments typically have holdings of a foreign currency, and when they lose confidence (for whatever reason) they will reduce their position, i.e. investment, in that currency. Correct me if I'm wrong, but several governments and institutions have reduced their US Dollar holdings, thereby weakening the value of the dollar. This can be good, as it makes our products cheaper overseas, but bad when you want to take that dream trip to Europe and you lose 35% when you buy Euros, for example. Again, a VERY simple explanation...

The yield (or interest rate) on accounts you have with them is always lower than what they lend at. To ensure they get that interest back, they have guidelines on how they determine your credit-worthiness and that determines if they will take a risk in lending to you, be it to start a business or buy a home. Bank rates are market-driven, but also affected by the Fed Monetary policy...if they raise or lower the prime lending rate, that affects rates on credit cards, mortgages, personal loans, etc.

Hope that helps, anyway. If you are interested in this more, I would encourage you to take a class on monetary/fiscal policy, macroeconomics, and international economics.


User currently offlineB2707SST From United States of America, joined Apr 2003, 1370 posts, RR: 59
Reply 3, posted (9 years 9 months 1 week 4 days 10 hours ago) and read 1234 times:

Quoting Duke (Thread starter):
Difficult questions, I know. Anyone major in economics here?

I knew that degree would come in handy sometime!

Quoting Duke (Thread starter):
1) how do the markets know exactly where a currency stands at any given time? How are these values calculated?

Currencies are constantly being traded around the world. In fact, the currency markets are the most liquid on earth, with an average trading volume of $1-2 trillion every day.

Since exchange rates are ratios, comparing more than two currencies creates the need for a common denominator. In the past, most currencies were simply units of a certain weight of gold, and exchange rates were simply whatever the ratio of these weights happened to be. Because all major currencies were tied to gold, exchange rates were fixed.

Now, because countries have abandoned the gold standard, most currencies "float" against each other, with the exchange rate being set by supply and demand. Just like the value of a stock, the current value of the exchange rate (the "spot price") is whatever the last successful trade was on a major market, such as New York or London. Because the markets are so huge and so liquid, any discrepancies between markets will quickly be eliminated by traders.

Quoting Duke (Thread starter):
2) how is money created? I understand that governments/national banks print bills and circulate them through banks, but what do the banks give the governments in exchange?

Technically, money can be created by physically printing new bills. However, with our extremely complex and highly computerized financial system, this would be a very cumbersome way to manage the money supply.

The primary tool of the Federal Reserve to control the money supply is called open-market operations. Explaining how open-market operations work requires some background information.

All major banking systems are classified as fractional reserve systems, meaning that banks do not have to hold the cash equivalent of all the deposits under their management on hand. They don't even need to have legal custody of an amount of money equivalent to their aggregate deposits. Instead, they only need to maintain a amount on hand, called their required reserves, equivalent to a certain percentage of their checking and savings deposits. This percentage, called the reserve ratio, is set by the Fed and is currently about 10%.

Banks can choose to hold reserves either in cash or in a deposit account at their local Federal Reserve branch bank (which does not bear interest). Since cash is physically difficult to handle and store, banks will only hold as much cash as they expect to need for transactions and will store the rest of their reserves at their Fed branch. These accounts are fully computerized; contrary to myth, there is no physical pile of cash sitting in a Fed vault, only an entry in an electronic ledger.

For example, say the Manhattan branch of Bank of America has $1 billion in deposits in checking and savings accounts. Assuming a reserve ratio of 10%, the bank must have at least $100 million in its Fed reserve account (less whatever cash it keeps onsite). The remainder -- $900 million -- can be lent out at interest, which is how banks make most of their profits.

Of course, the banks prefer as low a reserve ratio as possible, since they want to lend out money at interest rather than hold it in zero-interest reserve accounts or cash. However, if reserves get too low, there is the risk of the bank not being able to redeem all its deposits. For example, suppose Bank of America's customers try to redeem all $1 billion of their deposits simultaneously. If BoA has $1 million in cash and $99 million in reserve accounts, it can pay out $100 million but still can't meet all its obligations; the holders of the remaining $900 million in deposits are out of luck unless the bank can generate assets by calling in its loans. This is the danger of fractional reserve banking: by definition, banks do not have enough assets on hand to cover their liabilities.

Many economists believe this was an aggregating factor (perhaps the aggregating factor) that caused the Great Depression, as huge amounts of wealth held in deposit accounts were simply wiped out when banks collapsed. There is some disagreement about the remedy: some economists advocate a safety net like FDIC, which will bail out deposit-holders if the banks cannot redeem their deposits. Others think this simply encourages excessive risk-taking on the part of banks, since in last resort the government will bail out their customers, and want a higher (perhaps even 100%) reserve ratio.

Anyway, it usually happens that the exact amount of reserves a bank holds at its Fed branch is slightly greater or smaller than the amount required by the reserve ratio. Banks can lend each other reserves, and the interest rate they charge each other on short-term reserve loans is called the Federal funds rate. This is the interest rate targeted by the Federal Reserve through open-market operations, and when the media talk about Greenspan and company raising or lowering "interest rates," the specific interest rate being referred to is the Fed funds rate. Other interest rates (such as mortgage rates, short-term corporate and government bond rates, and credit card balance rates) are related to but usually not locked to the Fed Funds Rate.

The Fed controls the Fed funds rate by buying or selling US Treasury bonds to its member banks. When the Fed wants to raise the Fed Funds Rate, it will sell bonds to the banks. Instead of wiring the Fed money, the purchase price of the bonds is simply deducted from a bank's reserve account. But in this case, the bank's reserves are likely to fall below the amount required by the reserve ratio. As the bank adds additional balances to the reserve account to reach the reserve ratio, money flows out of the banking system and the supply of money in the economy falls.

This happens not only with one bank but with all major banks simultaneously. Because reserves are now scarcer, by supply and demand, the price charged for reserves (the Fed funds rate) goes up. The Fed will continue buying or selling bonds to the banks until it hits its target.

The opposite happens when the Fed buys bonds from its member banks: the purchase price is added to the banks' reserve accounts, raising the reserves about the amount required, allowing the banks to withdraw the excess and lend it out. Because more reserves are on hand generally, the Fed funds rate falls. Also notice that the amount of money in the system has increased.

There are further complications to the story that I will skip over here. But the crucial point is that the quantity of money in the economy is completely independent of the amount of hard currency in circulation. This may seem counter-intuitive at first, but imagine an economy in which all transactions are handled electronically by computers and credit cards. In this case, currency would entirely cease to exist, but there would still be a definite quantity of money in circulation, even though it could not be "seen" except on a computer screen.

Quoting Duke (Thread starter):
3) I have been told by some of my students who work in banks that a lot of money exists only in theory and that the governments do not create this money but that the economy (I.E. purchase and sale create this money). How is this possible? Is there any way of determining precisely how many Canadian dollars, American dollars, Euros, Czech crowns etc exist?

Yes and no; one has to define what money is first, and on this subject, there is considerable and often intense disagreement among economists. Everyone would agree that currency certainly is money, but are checking accounts? Money-market accounts? CDs? Brokerage accounts? Short-term bonds? Loan obligations?

There are four "monetary aggregates" that serve as generally accepted definitions of the money supply. However, there is no agreement on which is the best measure, and there are plenty of other aggregates that economists use for one purpose or another. In general terms, the four aggregates are:

- M0: currency notes and coin in circulation (currently about $703 billion)
- M1: M0 plus checking deposits and traveler's checks (currently about $1,372 billion)
- M2: M1 plus savings deposits (not checkable), CDs under $100,000, and non-institutional money market mutual fund shares (currently $6,446 billion)
- M3: M2 plus CDs over $100,000, repurchase agreements, dollar deposits held at overseas branches of US banks (called "Eurodollars"), and institutional money market mutual fund shares (currently $9,527 billion)

Of the four, M2 is probably the most watched, but as I said, there is disagreement. Another aggregate, called MZM, is gaining popularity; it includes M1 plus all money market accounts but no CDs of any size.

The Federal Reserve Bank of St. Louis publishes a blizzard of economic statistics, including weekly updates of the monetary aggregates, at http://www.research.stlouisfed.org/fred2/categories/24. Other central banks also publish monetary aggregates for their respective countries.

Quoting Duke (Thread starter):
4) why does printing a lot of money create inflation as a rule? I mean okay, if the government printed money and just handed it out to people, shops would as a rule raise prices, people would probably stop working and there would be chaos, but does it ALWAYS have to work that way?

To put it simply, the laws of supply and demand necessitate that whenever the supply of money increases, its "price" (which is really its purchasing power) will fall. Milton Friedman, probably the most famous monetary economist in history, famously said that "inflation is always and everywhere a monetary phenomenon."

However, what can and sometimes does occur is that inflation is masked by other economic developments. For example, productivity increases should cause falling prices, since more output is obtained from the same amount of input. But if there is ongoing growth in the money supply at the same time productivity is rising, general measures of inflation may be flat. However, there is inflation relative to what prices would have done had there not been growth in the money supply.

Two macroeconomic theories of the business cycle are especially based on monetary dynamics. These are monetarism, which holds that recessions are caused by sudden decreases in the money supply, and the Austrian School business cycle theory, which holds that increases in the supply of money push interest rates below their equilibrium level, leading to unsustainable booms in interest-sensitive assets like capital goods which then collapse when monetary injections cease (or even stop accelerating). Other theories, like Keynesianism, involve some monetary effects but are fundamentally based on non-monetary phenomena.

Quoting Duke (Thread starter):
For example, we know of the devaluation and inflation of the Deutsch Mark following WWI, when Germany printed a lot of money to cover its war debt. Why could Germany not just, for example, have printed several limited-edition 1,000,000 mark bills, sent them to the countries it was obligated to indemnify, and gotten on with life? Why did printing money to cover costs for an OVERSEAS transaction affect currency LOCALLY, when that money wasn't used for buying and selling things IN GERMANY? Or did the problem lie in an impossibility to pay the indemnity in cash, meaning that theoretic money had to be transferred to the other governments from the national banks, necessitating printing of big-value notes for use in Germany?

Your last sentence comes closest to the truth. Remember that no one holds money for its own sake; we only hold money for what (we expect) it will buy for us. If Germany sent England and France billion-mark notes like this one,



the receiving nations would eventually either exchange the mark notes for pounds and francs, or spend it for some goods or services denominated in marks. Any way you slice it, the money eventually gets back into the domestic economy and sets in motion the process of inflation. There is no way to wall off one unit of currency from the rest of the money supply. If Germany had issued mark notes with the provision that they count not be exchanged against other currencies or for German goods or services, they would have been nothing but Monopoly money: worthless pieces of paper with pretty writing on them.

--B2707SST



Keynes is dead and we are living in his long run.
User currently offlineDuke From Canada, joined Sep 1999, 1155 posts, RR: 2
Reply 4, posted (9 years 9 months 1 week 4 days 5 hours ago) and read 1217 times:

Very interesting information. I guess economics are simply a VERY complex area of specialization. I agree that a course someday might be useful.

Once my family received a pamphlet, I think from some minor political party, which basically said in a comic strip that the government should help the state by having banks "make money". It claimed something like what is said above - that only 10% of money is hard money, but said something like "the banks create 90% of the rest". It also claimed that banks' working is derived from the creation of the Bank of England (at the time of the reign of William III and Mary II), when the bank was given the right to "lend the same money twice". This sounds bizzare, and my students did not believe this last statement, which if it were true would effectively (seem to) reduce banks to a big pyramid scheme!

I wonder if it would be possible to create a United Nations currency which could be used in almost the whole world. I think it would greatly simplify things once implemented. Or would it? As is clear from my writing, I'm no economist.


User currently offlineCaptOveur From , joined Dec 1969, posts, RR:
Reply 5, posted (9 years 9 months 1 week 2 days 22 hours ago) and read 1193 times:

Quoting Duke (Thread starter):
Anyone major in economics here?

I have a follow up question. Anyone with a degree in Economics actually have a job using that degree?


User currently offlineYu138086 From , joined Dec 1969, posts, RR:
Reply 6, posted (9 years 9 months 1 week 2 days 14 hours ago) and read 1182 times:

My attempt at answering your questions:

1) The value of a currency relative to another is the demand or supply forces tha are placed on it in the currency markets. Big banks and governemnts can easily control the value of their currencies and others. Trillions of dollars are traded each day. Increase the value of X vs. the USD, then sell USD. Increase the value of USD vs. X then buy USD. (keep in mind I'm talking about billions of dollars here). Sometimes currency pegs are placed on one currency relative to another. These are artificial and usually last for 2-3 years to aid a countriews economic recovery. Stupid comments by world leaders that cause alarm among investors in their countries also cause currencies to rise/fall. The values and known to the thousandth of a decimal point (called PIPS) and are monitored by million dollar banking software.

2) It is usually by government decree that banks print/value money so the government owes the bank nothing for printing it. Priting it is usually necessary to increase various money supplies in an economy. Money is a unit of value and this value is determined by various factors. If nobody wants the money, its worthless.

3) Each country knows exactly how much money is in circulation in any given period. They determine how much money to save as reserve, inject into/ take out of an economy and invest. These amounts are easily measured.
Your friends don't know much. Goto the website of the Bank of Canada. All countries have national banks whose websites you can check statistics on. (i'll admit it can be a dry read)

4) The presumption is that when the money supply (through printing) is increased it will prompt people to spend becuase they have more $ to consume with. When people consume, prices tend to rise. When prices rise, inflation is created. Inflation can be mitigated by adjusting the level of interest rates. (the money supply is not the only controlling factor) Unemployment is not usually created by inflation. Rising prices simply means that the demand for goods are rising. If you are an industrialist and people are buying more of your goods, if you are smart, you willl hire more workers to produce more to meet the demand and charge more for your product.

Hope this helps.


User currently offlinePPVRA From Brazil, joined Nov 2004, 8976 posts, RR: 39
Reply 7, posted (9 years 9 months 1 week 1 day 20 hours ago) and read 1161 times:

Quoting CaptOveur (Reply 5):
I have a follow up question. Anyone with a degree in Economics actually have a job using that degree?

I would like to know that too. Anyone?

PPVRA



"If goods do not cross borders, soldiers will" - Frederic Bastiat
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