I am tired of hearing news readers talk about how the current financial crisis is caused by free markets, capitalism, and greed and that we need the government to fix it. Free markets and capitalism have nothing to do with it. The United States government has created the problem(accidentally or on purpose) with influence from greedy anti free market business people. I will try to keep this short, but there is a lot of ground to cover.
First, I must define inflation. Every economist agrees with the basic definition of inflation, but their definition is different than what the government and modern media use. If you hear someone talking about inflation you think about rising prices; ie food, gas, clothing, etc. The prices actually rise as a result of inflation, they are not the cause. Inflation is defined as an increase in the supply of money. In the old days a ruler would issue gold and silver coins that would be used in trade. Periodically the ruler would want to spend more than he could afford and didn't have enough money. So he would call in the coins, melt them down and reissue them with the same stated value, but slightly less gold or silver weight(either by making them smaller, or mixing them with cheaper metals). This was inflating the money supply. You still had 100 $1 coins, but there was less gold than before.
Gold was the most common money supply in the history of the world. Paper money had been tried in the US by several states and the US, but had always failed shortly when money got tight and the printing presses started running. Soon you could only buy a loaf of bread with a wheelbarrow full of money. That is one of the reasons our Constitution gave Congress the power to "coin"(not print) money. OUr founding fathers knew that printing money would destroy us. The US was basically on a Gold standard up until 1933. Sometimes gold was used as the actual medium or exchange, and sometimes paper money was issued that was backed by gold. If you lost confidence in the paper you could exchange it for gold. US Dollars were virtually 100% gold backed until 1933, and were mostly gold backed until 1971. A $20 gold piece(about 1 ounce of gold) was worth pretty much $20 until 1933(it is worth about $880 today).
In 1913 the Federal Reserve Act created the Federal Reserve. The Fed is a private company(semi government controlled) that manages the US money supply. The Fed is the third attempt at a national banking system. The other two only survived about 20 years. The Federal Reserve and the fractional banking system it created are the root of today's financial crisis. The Fed basically has the authority to create money out of thin air. Basically the Fed authorizes the sale of Treasury Notes to supply itself with money. Then it loans that money out to banks. Then the banks are(legally) allowed to loan out 10 times what they have on hand. So the Fed creates $1 Million and loans it to banks, those banks can then loan out $10 Million. They theoritically only created $1 Million, but the money supply was really increased by $10 Million so your dollars are worth less than before.
The Fed was handcuffed by the gold standard. They could not really create money until 1971 when the US went totally off the gold standard. In fact, Congress and President Nixon made it illegal to own gold in 1971. From then on the Fed could do whatever it wanted. It wanted to print money. It really began to perfect printing money while Jimmy Carter was president, but it got out of hand and had to be reined in or the US would have been bankrupt sooner. Since then the Fed has walked a tightrope with a rate of inflation(money printing) that was slow and steady enough that most people wouldn't notice, but that provided a steady flow of money the the Fed and it's stockholders. Using official government statistics. What cost $100 to purchase in 1967 now costs $656, and what costs $100 in 1982 now costs $220. But government has continued to grow and this wasn't enough. The inflation has really been growing recently. In 2006 the US government quit publishing M3 money supply data which basically showed the results of the Fed creating money out of thin air and then loaning it to banks that loaned out the same money 10 times. See this chart for the results.
First, I must define inflation. Every economist agrees with the basic definition of inflation, but their definition is different than what the government and modern media use. If you hear someone talking about inflation you think about rising prices; ie food, gas, clothing, etc. The prices actually rise as a result of inflation, they are not the cause. Inflation is defined as an increase in the supply of money. In the old days a ruler would issue gold and silver coins that would be used in trade. Periodically the ruler would want to spend more than he could afford and didn't have enough money. So he would call in the coins, melt them down and reissue them with the same stated value, but slightly less gold or silver weight(either by making them smaller, or mixing them with cheaper metals). This was inflating the money supply. You still had 100 $1 coins, but there was less gold than before.
Gold was the most common money supply in the history of the world. Paper money had been tried in the US by several states and the US, but had always failed shortly when money got tight and the printing presses started running. Soon you could only buy a loaf of bread with a wheelbarrow full of money. That is one of the reasons our Constitution gave Congress the power to "coin"(not print) money. OUr founding fathers knew that printing money would destroy us. The US was basically on a Gold standard up until 1933. Sometimes gold was used as the actual medium or exchange, and sometimes paper money was issued that was backed by gold. If you lost confidence in the paper you could exchange it for gold. US Dollars were virtually 100% gold backed until 1933, and were mostly gold backed until 1971. A $20 gold piece(about 1 ounce of gold) was worth pretty much $20 until 1933(it is worth about $880 today).
In 1913 the Federal Reserve Act created the Federal Reserve. The Fed is a private company(semi government controlled) that manages the US money supply. The Fed is the third attempt at a national banking system. The other two only survived about 20 years. The Federal Reserve and the fractional banking system it created are the root of today's financial crisis. The Fed basically has the authority to create money out of thin air. Basically the Fed authorizes the sale of Treasury Notes to supply itself with money. Then it loans that money out to banks. Then the banks are(legally) allowed to loan out 10 times what they have on hand. So the Fed creates $1 Million and loans it to banks, those banks can then loan out $10 Million. They theoritically only created $1 Million, but the money supply was really increased by $10 Million so your dollars are worth less than before.
The Fed was handcuffed by the gold standard. They could not really create money until 1971 when the US went totally off the gold standard. In fact, Congress and President Nixon made it illegal to own gold in 1971. From then on the Fed could do whatever it wanted. It wanted to print money. It really began to perfect printing money while Jimmy Carter was president, but it got out of hand and had to be reined in or the US would have been bankrupt sooner. Since then the Fed has walked a tightrope with a rate of inflation(money printing) that was slow and steady enough that most people wouldn't notice, but that provided a steady flow of money the the Fed and it's stockholders. Using official government statistics. What cost $100 to purchase in 1967 now costs $656, and what costs $100 in 1982 now costs $220. But government has continued to grow and this wasn't enough. The inflation has really been growing recently. In 2006 the US government quit publishing M3 money supply data which basically showed the results of the Fed creating money out of thin air and then loaning it to banks that loaned out the same money 10 times. See this chart for the results.
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