Could Someone Please Explain the Money Supply?

[Arnfinn Madsen]

How is our currency created (not physically)? In all of the discussion on economics, I have not yet seen anyone clearly explain how our money supply works. A few things I do know is that:

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1) Our currency is not backed by anything; it's just paper

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I see what you mean, but it is backed by something, it is backed by people's perception of it and also that it will i.e. be accepted for paying your taxes etc. to the government. A diamond or a share in a company that will go bankrupt tomorrow has a value today mainly due to people's perception of its value, and this perception is real. It is however important that it is dependant upon this perception, when people stop trusting the money as happens in different economies from time to time the consequences are very negative.
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2) Is inflation a byproduct of printing too much money?

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Yes, it can be put that way. Although too much is a disputable term, less would have to be printed in order to stabilize prices. But as above also part of inflation is due to people's expetance of inflation, prices rise partly due to the fact that you expect something to be more expensive than yesterday. But much of this expectancy is due to the constant norm of printing "too much" money, so at the basis of it all is the constant inflating of the money supply.
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3) The Federal Reserve controls a lot of this process

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In the US it is very powerful and can influence it a lot. However it is very hard to predict the exact effects of an action, so it could i.e. decide that it want inflation in 2 years time to be 20% and it would end up somewhere between 15% and 25%.

Do we:

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1) Consistently print more money than we destroy (on a federal level)

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Not consistently, sometimes the demand for money drops, so that the Federal Reserve will destroy more money than it prints, however the underlying trend is toward a constantly rising money supply.
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2) If so, who gets the benefit of this extra money printed?

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This is very complex, since the market can factor in a lot of this effects and thus minimize/eliminate them. I.e. if you borrow money in a time of high expected inflation you will be charged a high interest rate for that (in which the expected inflation is part of your interest rate). If the increase is unexpected everyone who has a loan benefits, so the government could print a lot of money to make it's own loans smaller in terms of real value. Also there are a lot of others who benefit, i.e. banks do it since a 50% increase in property value means the banks have 50% more security for its real estate loans in which the clients have mortgages.
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3) How do we keep track of the amount of digital money since most money now is not kept in hard currency?

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By putting in a computer that bank A has $2 trillion deposited at the Federal Reserve, that bank B has a claim of $5 trillion towards the Federal Reserve in government bonds. It is very simple. The Federal Reserve can basically make money by hitting a button.
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4) How do we find out how much money was created, either through printing or other creation, in the past year?
Further, how do we know how much has been destroyed?

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They keep detailed statistics of both, down to every cent.
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5) Why is our money not backed by something of value? Why did we decide to get off gold and silver standards? Doesn't this make more sense?

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Why does it have to? There isn't any need for it other than protecting money owners against the government. And history has shown us that that really isn't necessary, hasn't it? [img]/images/graemlins/grin.gif[/img]. Seriously, it is very convenient for the government to get rid of it as it has much more opportunities to influence the economy, and in countries like the US where the population trusts the government in this regard and the government keeps it actions within some reasonable standard it works well. If we should move to it being backed by something? I think in reality this is not doable in i.e. the US now.
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6) What is it that is currently backing our currency?

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See earlier answer.

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I feel completely ignorant as an American citizen as I know none of this. It really struck me because last night because I went to sleep watching CSPAN coverage of Bernake's testimony. Paul's opening comments were disturbing...every fiat currency system in history is failed. Why is he wrong? If he's not, why is this not a major political issue. I'm not trying to push Paul in 2008, I just really figured out that I have no idea what I'm talking about when I talk about economics, which is sad because I have a post-graduate degree from a business school.

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Nobody benefits from you knowing. It is very convenient that people in general do not know, since then people do not start to question it, and if too many people question it too much it actually collapses.