Synopsis

Over the years, many goods have been used as “money.” Because a good has been used as money in one situation does not make it money in all situations. The market determines by its use what good qualifies as “money.” The market in the United States generally uses something we call “dollars” as money. But, not all dollars qualify as money. The Federal Reserve creates dollars. Those dollars, however, do not qualify as money.

Definition of Money

Money consists of any economic good, or claim on such a good, that serves as a general medium of indirect exchange and that acts as a final means of payment.

Whether a good qualifies as money is determined by its use in the marketplace, not by its name. The market in the United States generally uses a good called “dollars” as money. All dollars, however, do not qualify as money. The phrase “serves as a general medium of indirect exchange” is an essential qualifier for which dollars can be used as money.

This phrase means that most, if not all, participants in a particular market must have ready access to dollars that qualify as money. The dollars created by the Federal Reserve do not meet this qualification.

General Acceptance

According to The Federal Reserve Banks’ website, individuals do not and cannot have access to dollars created by the Federal Reserve:

The Federal Reserve Banks provide financial services to banks and governmental entities only. Individuals cannot, by law, have accounts at the Federal Reserve.

[ Clipped from The Fed. ]

The prohibition of individuals having accounts with the Federal Reserve means that the dollars it creates cannot be generally accepted as a medium of indirect exchange.

When the Federal Reserve buys securities on the open market and adds dollars to the accounts of member banks, that does not create new money, contrary to popular misconception.

Conclusion

Many people mistakenly think that “dollars” created by the Federal Reserve act as money. Understanding that the dollars in reserve accounts do not act as money plays a vital role in understanding the monetary system of the United States.

Because the Fed does not make money, we need to reexamine the common hypotheses about the conduct of monetary policy. The influence of the Fed funds rate on interest rates in broader markets must also be examined. Popular models of banking structuring and processes must be questioned.

Since many of our conclusions about bank operations begin with the flawed premise that the Fed makes money, we should examine many of our conclusions about bank structure and processes.