Money and Central Banks

Document Type
Essay
Pages
6 pages
Word Count
2611 words
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N/A
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N/A
Money and Central Banks
1. The U.S. government owns about 4,500 tons of gold, stored mainly at Fort Knox
in Kentucky. Why did the government accumulate this gold? Should it continue to
hold the gold, or sell it?
ANSWER: The accumulation of gold by the U.S. government is related to the history
of the U.S. dollar. The experiment of issuing fiat money, the Continental dollar, failed
early in U.S. history. For almost 200 years, ending in the early 1970s, the U.S. gov-
ernment chose to issue money that was tied to gold in some fashion. With such a gold
standard, a country is required to exchange paper money for units of gold held by the
government. When the gold standard was given up in the United States, the govern-
ment still owned the gold that was stored in Fort Knox. Since gold does not play a role
in the issuance of money any more, the government can decide whether to hold or
sell the gold based on the impact of this sale on the overall government budget and
world gold markets. The difficulty of selling a large amount of gold is that the U.S.
government could influence world gold prices. If the U.S. government wanted to sell
gold, it would have to think about how to do this without making the gold market vul-
nerable to speculation. Selling large amounts of gold may also cause a crisis of con-
fidence in money and the economy in general because many people are not clear on
the fact that the government gold does not back money.
2. In the 1964 movie Goldfinger, the title character schemes to increase the price of
gold. He plans to drop an atomic bomb on Fort Knox, making the gold there ra-
dioactive. His operation is financed by North Korea, which hopes to make the dollar
worthless, disrupting the U.S. economy. If James Bond hadn’t thwarted Goldfinger’s
plan, what effects might it have had on the monetary system and economy in 1964?
ANSWER: Recall that in 1964 private citizens were not allowed to hold gold, except
to make jewelry. Only foreign governments were allowed to exchange dollars for gold.
Radioactive gold would only cause a problem if gold had to be physically shipped to
a foreign country. This would happen if foreign governments had dollar holdings that
they wanted to convert to gold. Clearly, safe shipping of radioactive gold would be
very expensive, if not impossible, causing a problem for the monetary system, in the
sense that foreign countries might not want to accept dollars as payments any longer.
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3. Scientists believe that the Sun will explode some billions of years from now. Ac-
cording to some economic theorists, this means that nobody should accept money
today. What is the logic behind this idea?
ANSWER: The United States today uses fiat money, pieces of paper that are not
backed by any commodity. Fiat money is only valuable when the holders of money
today believe that this money will be accepted as a medium of exchange tomorrow.
But tomorrow, the holders of money will find money useful only if they know that it will
be accepted the next day. Continuing this logic requires that people today need to be-
lieve that fiat money will be accepted in infinity in order for it to be valuable today. By
this logic, if people were worried about the Sun exploding some billion years from
now, they should stop accepting fiat money today. Since this does not happen, we get
some insight into people’s idea of infinity—maybe just a million years look like infin-
ity to us.
4. The U.S. population is approximately 300 million. Using the information in Table
2.1, calculate the average amount of U.S. currency per citizen. Do most Americans
hold that much cash? If not, where is it?
ANSWER: The total amount of currency in May 2010 was $882,000 million. For a
U.S. population of 300 million people this amounts to an average currency holding of
$2,940 per person. Clearly most people do not carry that much cash on a regular
basis. A lot of currency is held outside of the United States in countries where the
U.S. dollar is judged to be a better store of value than the local currency. Large cur-
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