Ain’t it funny?
In the monetary systems of the past, checking deposits were claims upon notes, and notes were claims upon gold (typically). If one questioned the good-standing of one’s checking deposit, one could redeem it for notes. Moreover, if one questioned the good-standing of one’s notes, one could redeem them for gold coin or bullion. But, how has this ‘questioning of good-standing’ been transposed to the current irredeemable fiat currency systems of the world?
In Tragedy & Hope: A History of the World in Our Time (available at the greshams-law.com book store), Carroll Quigley lucidly described the above monetary system as an ‘inverted pyramid’:
In each country the supply of money took the form of an inverted pyramid or cone balanced on its point. In the point was a supply of gold and its equivalent certificates; on the intermediate levels was a much larger supply of notes; and at the top, with an open and expandable upper surface, was an even greater supply of deposits. Each level used the levels below it as its reserves, and, since these lower levels had smaller quantities of money, they were “sounder.” A holder of claims on the middle or upper level could increase his confidence in his claims on wealth by reducing them to a lower level, although, of course, if everyone, or any considerable number of persons, tried to do this at the same time the volume of reserves would be totally inadequate. [Emphasis added.]
Today, the same structure exists with respect to deposits (that is, ‘IOU claims‘ upon central bank notes) and central bank notes. You can redeem your dollar deposits at your local commercial bank for Federal Reserve notes at any time you please (or so you think!). However, since the reserves backing the stock of ‘IOU claims’ upon Federal Reserve notes is wholly insufficient, if any sizeable number of persons decide to redeem, the folly of the pyramided money supply would unravel. However, what about the notes themselves? Is that where the buck stops? Are they the thing of all things? Are they the very bastions of solidarity and the essence of wealth?
Of course, they aren’t. Instead, the central bank notes of the world are merely the carcasses of former redeemable notes. There is no ‘promise’ as such, and there is no capacity to redeem or withdraw anything. Instead, they are irredeemable claims upon tiny proportions of their respective central bank’s portfolio of assets. Indeed, when central banks expand their balance sheets, these notes become irredeemable claims upon progressively tinier proportions of their respective central bank’s portfolios of assets. Moreover, as central banks alter the compositions of their portfolios of assets, they become irredeemable claims upon tiny proportions of their respective central bank’s altered portfolio of assets.
So, how is it that people ‘question the good-standing’ of these irredeemable fiat currencies in our modern age? The answer is that they swap them for what they are irredeemable claims upon. The Federal Reserve owns by and large, gold, government bonds and mortgage-backed securities. So, the ‘questioning’ manifests itself in higher dollar prices of these assets:
And yet all of this may seem rather funny, contradictory and paradoxical to the consensual market partipant. After all, aren’t bonds deflation things and gold inflation things? Aren’t Mortgage-backed Securities essentially part of the ‘risk asset’ universe? So shouldn’t MBSs be tanking with the stock market?
To be sure, this kind of market action is funny for us (as in haha funny), but it’s far from paradoxical…
Recommended: Charting the Federal Reserve's Assets - 1915 to 2012