The Dollar Is Not Redeemable In Gold But It Is Backed by Collateral

This is what the Fed says about the dollar, about our money:

Is U.S. currency still backed by gold?

Federal Reserve notes are not redeemable in gold, silver, or any other commodity. Federal Reserve notes have not been redeemable in gold since January 30, 1934, when the Congress amended Section 16 of the Federal Reserve Act to read: "The said [Federal Reserve] notes shall be obligations of the United States….They shall be redeemed in lawful money on demand at the Treasury Department of the United States, in the city of Washington, District of Columbia, or at any Federal Reserve bank." Federal Reserve notes have not been redeemable in silver since the 1960s.
The Congress has specified that Federal Reserve Banks must hold collateral equal in value to the Federal Reserve notes that the Federal Reserve Bank puts in to circulation. This collateral is chiefly held in the form of U.S. Treasury, federal agency, and government-sponsored enterprise securities.

Keep in mind that this is base money that the Federal Reserve bank puts into circulation, not all money,  that is backed by collateral. Of course, the quality of collateral is important. Treasuries have good quality because the US government has never defaulted and because the demand for treasuries is immense as I wrote at Talkmarkets:

Future Insatiable Bond Demand

However, one must understand that bond demand is greater than it should be even when the economy is expanding and that may affect the willingness of banks to lend. They may not lend when they don't have to do so. Certainly the Fed does not want the bank excess reserves to get out into the public because demand for bonds would have to be even stronger. This demand is distorting the behavior of the long bond.

Perhaps an audit of the Fed would allow us to see if this rule is being followed properly. 


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