Open your wallet and take a look at the money you have inside. Hopefully you have some metallic coins and slips of paper (actually its linen). Take a closer look. At the top in large letters it reads: 'FEDERAL RESERVE NOTE.'

The Federal Reserve is the central bank of the United States. It issued the money you hold in your hands, although the Department of the Treasury actually printed it. Although it has the word 'Federal' in the title, the Federal Reserve is a private bank or company delegated the power by Congress to manipulate the money supply. It is no more 'federal' than Federal Express or Wal-Mart for that matter. More on this later.

Now, far more curious is the use and definition of the financial term 'note.'

Note - A written promise to pay a specific sum of money on a certain date. A written pledge to pay.

Interesting. A 'Note' is actually a form of Debt, i.e. you are owed its worth by the United States government. The linen also has text "THIS NOTE IS LEGAL TENDER FOR ALL DEBTS, PUBLIC AND PRIVATE." 'Legal Tender' is a legalese that means money that cannot be refused by law when you are paid or go to buy something.

But what is this note for debt actually worth? A common fallacy is that the worth of the dollar is indirectly tied to the gold at Fort Knox. Dead wrong! Another is that the dollar is tied to the nation's GDP/GNP/purchasing-power parity. There is some truth to this, as the dollar's worth 'floats' or fluctuates with the exchange rates of other currencies like the Euro and Yen, but what is a dollar actually worth?

Well, fortunately, the Federal Reserve is kind enough to tell us. Visit this Fed link entitled "What is a Dollar Worth?"

There is a nice formula: "If in [year], I bought goods or services for [$1.00] then in [year], the same goods or services would cost [$x.xx]"

Try the year 2008, how much was a dollar worth in 1913? Holy smokes, just a nickel!

Well perhaps that was just because it was way before you were born. Try the year 2008, how much was a dollar worth in 2000? Just eighty cents worth of goods and services? That kind of sucks, and 8 years isn't all that long for the value to drop by 20%! Something is a little fishy here.

Of course the answer for this debasement of the currency, or loss in value, is inflation.*

What is inflation then? Well picture the United States, and imagine that $100 is the total worth of our economy. However, if we print and additional $100 and so increase the money supply from $100 to $200, then the price of everything will double. After reading Rothbard's work from Part 1, one discovers that inflation is defined as any increase in the economy's supply of money not consisting of an increase in the stock of the money metal. In other words, inflation is NOT rising prices. Rising prices are merely the effect from increasing the money supply, or "printing more money."

However, the second part of Rothbard's definition doesn't really apply, as I wrote above that there is no tie between the US dollar and a "money metal." More on this in Part 3. To prove this point, the Federal Reserve reports:

"The government still holds millions of ounces of gold and silver, but citizens and foreign governments can no longer exchange their US paper money for it. The government's gold and silver are considered valuable assets rather than forms of money. Today's coins and paper money are backed by the "full faith and credit" of the US government.

If that makes you a little uneasy, try the following exercise. Put a ten-dollar bill and a blank piece of paper on a tabletop, and ask people to choose between the two. Chances are everyone will choose the ten-dollar bill. Why? After all, neither the ten-dollar bill nor the blank piece of paper is backed by gold or silver.

The difference is that people all over the United States will accept the ten-dollar bill as payment if you want to buy something. But you would have a hard time finding someone willing to accept the blank piece of paper. That's because the ten-dollar bill is backed by the promise of the United States government, and to most people, that promise is as good as gold." - "Banking Basics", Federal Reserve of Boston, revised 1/2007

So "full Faith and Credit" is the answer. Faith is just the belief that the government will pay you back - like the Fed excerpt hints, Faith alone in the value of the money is certainly not acceptable. Credit is a different matter, and actually the only reason why people would have Faith in the first place is they trust the government's promise to back it up. As John Williams, the renowned economist from shadowstats.com, testified to Congress on July 24, 2008:

"The relative value of a nation's currency is a measure not only of its trade position, but also of global capital flows that mirror how the rest of the world views that nation's economic strength, financial system integrity and political stability. Underlying fundamentals that drive the relative value of the US Dollar, against the currencies of its major trading partners, could not be much more negative."

Williams brings up an important point, which is that in today's monetary system all currencies float against each other, although many Asian countries, for instance, peg their value to the dollar. A "strong dollar" is indeed very important as a weak dollar would enable other foreign countries to have a higher purchasing power and buy up American goods and assets cheaply - boosting our exports but most importantly depressing our purchasing power domestically. Also, the cheap imported goods from China and oil will become relatively more expensive for us as we buy in American dollars, but other countries' purchasing power will be stronger and it will be easier for them to outbid us for the goods.

I need to pause here for a moment to describe just how important Purchasing Power really is. If you have $100,000 in 2000 and can buy 10 cars, and have $100,000 in 2010 but can only buy 1 car, you may have the same amount of dollars, but you have lost 90% of your purchasing power. So please rid yourself of the preconception that your Wealth is calculated by how many Dollars you have (and that your home is worth as much as you think it is). Real Monetary Wealth has and always will be determined by your Purchasing Power, in other words, how much you can Buy. Real Materialistic Wealth is a combination of your Monetary Wealth combined with all of your property and assets.

Williams goes on to present some solutions to strengthen the dollar but also reviewed a dollar portfolio that "could not be much worse:"

• "Trade Balance (Negative): Despite recently reported narrowing of the monthly trade deficit, the US trade shortfall remains unprecedented in its relative global magnitude
• Economic Activity (Negative): US business conditions are deteriorating, with the economy clearly in a recession in all but formal declaration
• Inflation (Negative): US inflation has risen sharply, with the CPI-U up 5.0% year-to-year as of June; broad money growth is highest since 1971; double-digit inflation is possible by early 2009
• Fiscal Discipline (Negative): The already expanding US federal budget deficit likely will be worse than expected, thanks to the developing recession
• Interest Rates (Negative): US interest rates are low, with Federal Reserve policy perceived to be on hold per current market expectations
• Political/Systematic Stability (Negative): The President's approval rating (currently low) is a fair indicator of currency trends; the banking crisis is a negative"

Later in this series we will delve more into the above more, but for now just note that each parameter that influences the dollar is fairly soft - there is nothing concrete that stipulates exactly how much a dollar is worth. Still believe the Fed's claim that the Dollar is "good as gold?" Even if there is really no gold or other tangible backing?

Let me now introduce the US Dollar Index (USDX). The USDX is a weighted basket of six (6) freely floating currency exchange rates with the US dollar - the Euro, Yen, Swiss Franc, British Pound, Swedish Krona, and Canadian Dollar. The index was originally set to 100.00 when the index was started in 1973, so this reflects the average value of the dollar relative to that period. The USDX is computed 24 hours a day, see it live here.

Source and formula

Next, from the chart below, the USDX is in a major bear market. Having reached a high of 120.97 in July 2001, the USDX is now slightly above its all-time low of 71.33, set in April 2008. Combined with all of the factors Williams delineated above, there are no positives and only negatives, so it is highly likely that the USDX will continue downwards in the future, the only unknown is whether this will be sudden or gradual. Let's reflect for a moment on the loss of our wealth.

Since 2001, the Dollar has lost 41% of its overall purchasing power versus the USDX basket.

Since 2001, the Dollar has lost 18% of its domestic purchasing power to inflation.

Source

As it would be quite difficult to even counter this loss by saving the dollars in a bank, surely the speculations or investments into Wall Street, into 401k retirement "savings" ** accounts, index mutual funds, and the like would yield a better return? Only if you were smart and/or lucky!

Source

On January 14^th, 2000, the Dow Jones hit a contemporary high of 11,723 with the USDX at about 105. In October 2007, the Dow set its all-time high of 14,164 - in dollars, that is. The USDX was about 75. So if priced in USDX units, the Dow was only worth about 10,100, or factoring in just domestic inflation about 11,600 in year-2000-dollars.

And as of August 1, the Dow is at 11,326 with the USDX at 73.36. Price the Dow today in the USDX, and it lost 30% from 2000 - it is worth just 7,900 in 2000's dollars. Inflation adjusted the figure is 9,100. Although these figures don't factor in dividends, investing in the Dow (or S&P 500) was unable to generate extremely high gains on a purchasing power basis, as is generally believed.

So, most Americans have been actually been robbed in this decade - whether a saver or investor or speculator - due to the loss of purchasing power in the dollar due to the drop in currency exchange rate and money supply inflation. Anyone upset?

To succinctly answer the question posed, a dollar is worth whatever Americans and the international community believes it is worth per the six factors Williams listed above. There is no hard way to calculate its true purchasing power, which fluctuates at all times, and increasing the money supply (or inflation) is debasing the dollar at significant rates. A dollar bill's intrinsic value is no higher than any other slip of paper, in fact from the Fed's comparison above, the blank piece of paper may be worth more, since it's a commodity that can still be written on.

It would be of great value to read Rothbard's "What Has the Government Done with Our Money?".

The next article will review a basic question - what is money anyways? What are its properties?

* On the same page there is a link 'Consumer Price Index and Inflation Rates, 1913-' where the column on the right gives the inflation rate for the year. However, the CPI calculation method, particularly in recent years is under dispute. John Williams of shadowstats.com believes the current inflation rate is over 10%, not below 5%. If you regularly visit gas stations and supermarkets, you would probably agree less than 5% is not possible.

** Actually even the true meaning of what savings really are have been lost, as the common man has been driven to the stock market for higher returns, see aside here.

Technorati Tags: Federal Reserve, Central Banking, Economics, Money, Monetary Policy

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