4
$\begingroup$

We know that the money today is fiat currency, that it is money because the government says it's so. So when new money is printed or loaned out to the commercial banks by buying treasury bonds, government does not technically "owe" any thing. The only thing that is stopping it from creating new money every time need arises is the possibility of inflation.

Given all of that why is still money in circulation listed as a liability of the central bank? Am I missing something here?

$\endgroup$
4
$\begingroup$

Balance sheets always balance, so assets equal liabilities.

Imagine a commercial bank goes to the central bank and wants cash. The central bank provides the cash, but asks for some of the commercial bank's loans (or government bonds) in return.

The central bank now has the loans (or government bonds) as assets and the cash as liabilities.

The cash is a liability, because if the commercial bank goes back to the central bank and gives back the cash, the central bank will have to give back the loans (or government bonds).

So while it's true that cash is not backed by gold, it is still backed by something. You can take your cash to the central bank, exchange it for government bonds, earn cash interest on your government bonds and then use this cash to pay your taxes. More generally cash is backed by the goods that you can purchase for it.

$\endgroup$
  • $\begingroup$ The point being here that even government bonds yield their returns in cash, which is again printed by government. The only thing that it is balanced by seems to be taxes, sounds like the chartalist theory of money. So my understanding is that it is more of an accounting thing rather than anything else. Please correct me if I am wrong. $\endgroup$ – Kiran Yallabandi Aug 22 '17 at 12:04
  • 1
    $\begingroup$ Yes, money is valuable because you can use it to pay your taxes. So the baker will take your money, because he knows he can use it to pay his taxes. However, money is also valuable, because you trust the central bank to keep money growth in line with economic growth and keep inflation low. When this breaks down, money can become pretty worthless, as many historical examples demonstrate, and people indeed abandon it and start using US dollars, gold or cigarettes. $\endgroup$ – M3RS Aug 22 '17 at 12:22
  • $\begingroup$ So I agree with you, fiat money is something delicate and it can quickly become worthless if trust evaporates. $\endgroup$ – M3RS Aug 22 '17 at 12:23

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.