How Currency Gets into Circulation and What Happens to it

Posted by Thomas DeMichele

The U.S. Fiat Currency System Explained Simply

Below we explain how currency gets into circulation via the Treasury, Federal Reserve, and banks, and the role Congress, banks, businesses, and you play in the process. We’ll also describe how the initial reserves become the economy in practice, the Fed’s role in controlling the money supply, and how money goes back into the system to help pay back our national debt.[1][2][3]

The topic is a little complex, so consider watching the videos for more insight.

Author’s note: I couldn’t find one source that explained central banking and how currency gets into circulation (not the simple answer, but the correct full answer). Given this, I’ve amalgamated a great deal of information below. I can’t promise that every detail is perfect at the moment, however I’ll be revising as I can figure out more. Please comment with insight and double check specifics as needed.

How Currency Gets In and Out of Circulation – Summary

According to the Federal Reserve:[4]

There are about $1.7 trillion dollars of U.S. currency in circulation as of Dec 2018 (that is counting federal reserve notes and coins only).

The Federal Reserve Banks distribute new currency for the U.S. Treasury Department, which prints it.

Depository institutions buy currency [federal reserves] from Federal Reserve Banks when they need it to meet customer demand, and they deposit cash at the Fed when they have more than they need to meet customer demand.

Or at least, that is the simple version. Below I’ll add some nuance and complexity so you can better understand how currency gets into circulation and how it relates to the total money supply.

Reserves, Bank Credit, Fractional Reserve Banking, and Broad Money

The key to understanding “money in the US” and not just “dollars in circulation” is understanding the relationship between the treasury, federal reserve, banks, and congress, how that relates to federal reserves, bank credit, and the concept of broad money, and how all of that relates to the total “broad” money supply in circulation.

Congress, Treasury, Fed, Banks: In overly simple terms, Congress spends and taxes. When congress spends more than it taxes, the Treasury has to issue bonds (IOUs) to raise money. The Federal Reserve (our central bank) buys Treasury bonds and then issues reserves based on that.

Private banks then hold reserves and lend based on those reserves. Then people and businesses use reserve notes and bank credit to participate in the economy. The economic activity of banks, businesses, and people produces tax revenue. Tax revenue is paid back to the Treasury via the IRS. This is explained in detail below.

Reserves and bank credit: Reserves come in two forms 1. reserve notes (physical currency and coins; in an electronic or paper form), and 2. reserve deposits (things like treasury bills and gold held in deposit at the Federal Reserve which commercial banks can hold as assets to meet deposit requirements and can convert into reserve notes to meet customer demand).

Reserve notes are used as legal tender currency (official dollars) used by everyone, but reserve deposits are only used by the Federal Reserve and private banks. Bank credit meanwhile is what most of the money supply consists of, this is credit lent by private commercial banks based on reserve notes and deposits held. This system of lending based on reserves is called “fractional reserve banking” (the modern banking system).

Money creation in the modern economy; Bank of England Quarterly Bulletin PDF

https://www.youtube.com/watch?time_continue=10&v=U8Yn5jT8Hyc&feature=emb_logo

https://www.youtube.com/watch?time_continue=2&v=I72Lp8WCRpU&feature=emb_logo

To continue reading, please go to the original article here:

http://factmyth.com/how-currency-gets-into-circulation-and-what-happens-to-it/