What gives a dollar bill its value? - Doug Levinson

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The value of money is determined by how much (or how little) of it is in circulation. But who makes that decision, and how does their choice affect the economy at large? Doug Levinson takes a trip into the United States Federal Reserve, examining how the people who work there aim to balance the value of the dollar to prevent inflation or deflation.

Lesson by Doug Levinson, animation by Qa'ed Mai.

If you tried to pay for something

with a piece of paper,

you might run into some trouble.

unless, of course, the piece of paper

was a hundred dollar bill.

But what is it that makes that bill

so much more interesting and valuable

than other pieces of paper?

After all, there's not much you can do with it.

You can't eat it.

You can't build things with it.

And burning it is actually illegal.

So what's the big deal?

Of course, you probably know the answer.

A hundred dollar bill is printed by the government

and designated as official currency,

while other pieces of paper are not.

But that's just what makes them legal.

What makes a hundred dollar bill valuable, on the other hand,

is how many or few of them are around.

Throughout history, most currency,

including the US dollar,

was linked to valuable commodities

and the amount of it in circulation

depended on a government's gold or silver reserves.

But after the US abolished this system in 1971,

the dollar became what is known as fiat money,

meaning not linked to any external resource

but relying instead solely on government policy

to decide how much currency to print.

So which branch of our government sets this policy?

The executive, the legislative, or the judicial?

The surprising answer is, none of the above!

In fact, monetary policy is set

by an indepdent federal reserve system,

or The Fed,

made up of 12 regional banks

in major cities around the country.

Its board of governors,

which is appointed by the President

and confirmed by the Senate,

reports to Congress,

and all the Fed's profit goes into the US treasury.

But to keep the Fed from being influenced

by the day to day vissisitudes of politics,

it is not under the direct control of any branch of government.

So why doesn't the Fed just decide

to print infinite hundred dollar bills

to make everyone happy and rich?

Well, because then the bills wouldn't be worth anything.

Think about the purpose of currency,

which is to be exchanged for goods and services.

If the total amount of currency in circulation

increases faster than the total amount of goods and services

in the economy,

then each individual piece would be able

to buy a smaller portion of those things than before.

This is called inflation.

On the other hand,

if the money supply remains the same,

while more goods and services are produced,

each dollar's value would increase

in a process known as deflation.

So which is worse?

Too much inflation

means that the money in your pocket today

will be worth less tomorrow,

making you want to spend it right away.

So, while this would stimulate business,

it would also encourage overconsumption,

or hoarding commodities, like food and fuel,

raising their prices,

leading to consumer shortages and even more inflation.

But deflation would make people

want to hold onto their money,

and a decrease in consumer spending

would reduce business profits,

leading to more unemployment

and a further decrease in spending,

causing the economy to keep shrinking.

So most economists believe that

while too much of either is dangerous,

a small, consistent amount of inflation

is necessary to encourage economic growth.

The Fed uses vast amount of economic data

to determine how much currency should be in circulation,

including previous rates of inflation,

international trends,

and the unemployment rate.

Like in the story of Goldilocks,

they need to get the numbers just right

in order to stimulate growth and keep people employed,

without letting inflation reach disruptive levels.

The Fed not only determines

how much that paper in your wallet is worth

but also your chances of getting or keeping the job

where you earn it.