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From my understanding, all new money enters the market either 1) by the Fed lending it to banks, so the Fed essentially owns bonds in the exchange, or, 2) The Fed purchasing other financial assets. So for each new dollar, it is represented by some new security in the Fed's "vault". This doesn't sound like it's unbacked to me. Hypothetically, if the Fed and the dollar "went under" would there not be some obligation to distribute these securities among all dollar holders?

Furthermore, what is stopping the Fed from acting like a fund where each dollar represents a (very) small percentage of all securities in "the vault". To me, it seems like this would create a basis for value of the USD. If a USD-holder were able to trade in his dollar for tangible securities, would this not increase his confidence in the system itself? What's the reason the Fed doesn't operate this way?

Very interested in hearing more educated responses to this, thanks in advance.

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When the Fed purchases something, it creates the money to do so out of thin air (it just changes the balance in a bank's Fed account. Click, click.). Similarly when the fed is paid, the dollars disappear. From the Fed's perspective, dollars are very ephemeral and not backed by anything.

Dollars are not like debt. They don't entitle you to anything the Fed owns. The Fed can't "go under" in the normal sense of word (bankruptcy) because it has no obligations to repay or if it does, it creates the money to pay those obligations with no limitation. It goes under only by an act of law.

It would be possible for the government to abolish the fed and take its assets, but that doesn't sound much like a fund to me--there is no reason to think those assets, whichever ones remain meaningful in that context, would be disbursed to dollar holders. I would expect them instead to be kept by the treasury and used to reduce the national debt.

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So for each new dollar, it is represented by some new security in the Fed's "vault". This doesn't sound like it's unbacked to me.

When you look at case number 1, the Fed lends money to the bank, the bank can ask more than the assets it owns (e.g. asking for 2M when all the cash and bank assets are worth 1M). This means that the debt of the bank is accounted for and will be paid back with interest - but it is not backed. If the bank doesn't pay, even seizing all the bank's assets wont pay the debt back.

what is stopping the Fed from acting like a fund where each dollar represents a (very) small percentage of all securities in "the vault"?

The dollar, as it is, already serves the functions it needs to fulfill. Central banks / the Federal reserve have the job to maintain the stability of the monetary system, meaning controlled inflation and exchange rates. They do so by influencing the interest rates. The fact that the government backs a currency, and the independence of the federal reserve from the government gives it credibility on its own.

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  • $\begingroup$ Thanks Limonada. So in section 1, if I'm understanding you correctly, the security itself is unbacked because it is based on credit and not an asset. This makes sense, but the security still represents a legal obligation that most likely will be repayed and represents some small profitable investment as a bond. Maybe this is just a matter of semantics, but does the bond (because it holds value) not back the value of the dollar (meaning it represents a relative portion of the value of a dollar). $\endgroup$ – Brendan Jan 18 '18 at 20:31
  • $\begingroup$ Also, in section 2, while I agree with you that the USD is credible based on these factor's and the fed's balance sheet, etc, I don't know if this sentiment is shared by the average cryptocurrency investor, which there are a lot of at the moment. So given this widespread sentiment of lack of credibility, I was just wondering if there is a particular reason the system isn't more blatantly credible for this large group of it's users. $\endgroup$ – Brendan Jan 18 '18 at 20:40
  • $\begingroup$ No, the bond or loan does not hold value per se - it holds a future right to be repaid, which was not yet earned, and in has no colateral if defaulted. When you ask for an unbacked loan to your bank, if you dont repay it the bank will transform a "bond from you to the bank" into a loss. About the uncredibility, that's another question. If you do that question in this forum, please add your sources for that claim. $\endgroup$ – JoaoBotelho Jan 19 '18 at 2:16
  • $\begingroup$ A bond does hold value because you can sell it. The value of anything is ultimately determined by sales price (by definition). Debt has a statistically quantifiable profit expectation attached to it. I'm not making any claims, just observations of sentiment, so I don't know how to attach a source except for "Matt thinks Bitcoin is a great idea because he thinks the federal reserve is evil and the value of the usd is baseless". $\endgroup$ – Brendan Jan 20 '18 at 7:59

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