Wondering what 'debt ceiling' is? [Part 2]

We stopped the last time at the 'Federal Gold Reserve' concept that came up in Die Hard 3.

A gold reserve is the gold held by a central bank or nation intended as a store of value and as a guarantee to redeem promises to pay depositors, note holders (e.g., paper money), or trading peers, or to secure a currency. (Details here)

A very good explanation of the term 'store of value' can be found here. A snippet from the same below.

While these items (like gold) may be inconvenient to trade daily or store, and may vary in value quite significantly, they rarely or never lose all value. This is the point of any store of value, to impose a natural risk management simply due to inherent stable demand for the underlying asset. It need not be a capital asset at all, merely have economic value that is not known to disappear even in the worst situation. In principle, this could be true of any industrial commodity, but gold and precious metals are generally favored because of their demand and rarity in nature, which reduces the risk of devaluation associated with increased production and supply.

 This means that it is not necessary for 'all of a nation's currency value equivalent' to be present in the gold reserve but just a minimal fraction that is necessary to 'secure' the currency from collapsing.

 However, the gold reserves at the Federal Bank of New York (that appears in Die Hard 3) is kinda a different store that was a result of a Gold Reserve Act in 1934 that outlawed most private possession of gold, forcing individuals to sell it to the Treasury, after which it was stored in United States Bullion Depository at Fort Knox and other locations. This act was reverted later though in 1975. More details here and here.

The general definition of a central 'reserve' bank in Wikipedia here was as follows:

 The primary function of a central bank is to manage the nation's money supply (monetary policy), through active duties such as managing interest rates, setting the reserve requirement, and acting as a lender of last resort to the banking sector during times of bank insolvency or financial crisis.

A ton of the terms above did not make sense again as well J

 The reserve requirement (or cash reserve ratio) is a central bank regulation that sets the minimum fraction of customer deposits and notes that each commercial bank must hold as reserves (rather than lend out). These required reserves are normally in the form of cash stored physically in a bank vault (vault cash) or deposits made with a central bank. More details here

 A lender of last resort is an institution willing to extend credit when no one else will. The term refers especially to a reserve financial institution, most often the central bank of a country, intended to avoid bankruptcy of banks or other institutions deemed systemically important or 'too big to fail'. More details here

 Another question that crops up is - How do interest rates help manage economic growth and stability? Let's try to answer this in the next part in this series.

Wondering what 'debt ceiling' is? [Part 1]

Have been really overloaded at work over the past couple of years :( with little to no time for social life. Decided that this had to come to a stop! So, here I am blogging again. Guess I still need to get into the mood for short stories again but until then - it's about sharing some stuff I have been reading.

Of late, have been hearing a lot around the fact that US is gonna hit its debt ceiling. Being a person who has generally kept oneself away from economics in general (am pretty cosy and comfy in the world of code :)), I always used to wonder what that means.

Trying to dig up details around the same took me through a fascinating journey of how the global economy works. Read on if you would like to accompany me in the journey. Many of these might be a no-brainer for folks in the United States though. Would be publishing this in a multi-part article series since it was kinda too much for a single post.

Started off with http://en.wikipedia.org/wiki/United_States_debt_ceiling, figured out that I could not understand more than half the terms in this article :)

First of all - couple of definitions

• The term 'US Federal government' refers to the political entity characterized by the union of the 50 partially self-governing states that constitute the United States. In that sense, India is also a 'federal state'
• The federal government is composed of three distinct branches: legislative (Congress), executive (President) and judicial (Supreme Court). More details here
• The Treasury is one of the departments of the US Federal government. The Treasury prints and mints all paper currency and coins in circulation. The Department also collects all federal taxes through the Internal Revenue Service, and manages U.S. government debt instruments. More details here.
• IRS - Internal Revenue Service - This is another term that I have often heard in hollywood movies. It used to put a shocked expression on the face of the actors whenever it was announced. Decided to read up a bit more around the same. Put simply, this is the tax collection division for the US. More details here

Now, an interesting question - how did money (paper and coins) become the medium of trade? This link had a pretty good explanation for the same - given below -
Prior to the introduction of banknotes, precious or semi-precious metals minted into coins to certify their substance were widely used as a medium of exchange. The value that people attributed to coins was originally based upon the value of the metal, but over time, coins developed a value in their own right which might have differed substantially from the metal from which they were made. Banknotes were originally a claim for the coins or precious metals held by the bank, but due to the ease with which they could be transferred and the confidence that people had in the capacity of the bank to settle the notes in coins if presented, they gradually became a means of exchange in their own right. They now make up a very small proportion of the "money" that people think that they have as demand deposit bank accounts and electronic payments have negated the need to carry notes and coins.

The next question I had based on the above was that - if at some point in time - notes were exchanged for metal - then some bank must have the 'metal' equivalent of the original sum. This is where the concept of the 'Federal Reserve' comes in. Ring a bell? For me - it was Die Hard-3 :). More around this in the next part. Stay tuned.