Saturday, October 18, 2014

Reality Finance/Millionaire Challenge and Everything You Need to Know About Finance in a Few Blog Posts, Part 2

Hey everyone.
As promised in my last post, today, we will talk about how specifically the government creates money and how it directly and indirectly controls where that newly created money flows. (This concept is called monetary policy.) But in keeping with my reality finance/millionaire challenge theme, I'd like to let everyone know where I stand financially as of today.

In the past three or four days, I've made $2,000.00. After paying my personal bills, paying my law firm's bills,  and contributing to my retirement and savings accounts, as it stands now, my liquid net worth is $1,986.84. However, only $1,680.84 of that money will not be touched. The remaining $306 will be used for regular living expenses and tiding me over until the next time I will receive money, which will be on this Monday, October 20, 2014.

My credit score just got bumped up to a semi-respectable 645 and my outstanding credit card balance is currently $813. In another post, I'll explain to you why you shouldn't be so concerned with your credit score, as opposed to being concerned with acquiring liquid assets. But I did want to give you all those pieces of information so you can see exactly where I stand with regard to my finances. Now, time for today's finance lesson.

Who controls money and how is it done?

In my last post, I talked about how nowadays, virtually every economy in the world operates on a fiat currency system. Because of this system, and the fact that money is essentially not backed by any physical commodity, an endless amount of money can be created.

Paper money is printed and metal coins are minted by the United States Department of Treasury. The Department of Treasury works hand in hand with the Federal Reserve to make sure that the economy stays healthy, that people are buying enough goods and services, that the amount of goods and services that a person could purchase last year is not too different from what that same person can purchase with the same amount of money this year.

The Federal Reserve (or "Fed" as you might hear it called on t.v.) was created in 1913, and was created in order to among other things, gather information on what is going on in the economy and how to make it stable. The Fed is not apart of any of the three branches of government, but it is subject to oversight by Congress.The Fed has twelve branches around the country - mostly in major cities like New York, San Francisco, and Boston, for instance - and these branches are the foot soldiers of the Fed. The Fed, which is often referred to as the banker's bank, through its twelve branches, lends to private banks. These private banks which receive funds from the Fed are what allow for the United States economy to run smoothly.

The gross domestic product of the United States is $13 trillion. In order to arrive at an economy so large, and because we no longer live in a system whereby money is backed by a physical commodity or service, some merchant had to have someone put trust in her that if the merchant were lent money, value would be created and the money lent out would be paid back with interest. Hence, the saying that our entire economy is one based on credit. And that is certainly true. Most Western governments, unfortunately, are operating largely on credit.

The United States, because it is the most powerful, stable and wealthiest nation in the world, can print money and have everyone around the world believe that that money is worth something. The United States can also ask for a line of credit, by issuing treasuries to people, corporations, or even other countries, and can always get that line of credit because it is so wealthy and stable.

The branch of the of the Fed that is responsible for making sure that the economy is stable, and making adjustments if the economy is not - the Federal Open Market Committee - meets periodically throughout the year. When it meets, it takes a look at whether unemployment is high, whether inflation is high, and then makes a decision as to whether more money should be put into the economy. If the determination by the FOMC is that more money should be put into the economy - i.e. for instance, if private banks are not giving out credit easily, or if corporations are not hiring - the Fed can print more money, or buy Treasury bonds. In fact, this is what has been happening lately.

The Fed currently wants to jump start the economy, but does not want to devalue American currency and create inflation (which would happen if more money were printed). So it has decided to make the interest rate at which it lends to commercial banks low and to buy back a lot of the debt it has issued, making the economy flush with cash. This is known as quantitative easing.

In my next post, I'll talk about interest rates and how exactly this affects your credit card payment, mortgage rate, student loans, and even the bond and stock markets. Stay tuned and until then, I hope you continue to live richly.

Reality Finance/Millionaire Challenge and Everything You Need to Know about Finance in a Few Blog Posts, Part 1

Hey everyone.
Today's post is intended to give you all a bird's eye view and general understanding of how the global economy and financial markets work. But before I get into that, I just wanted to let you know where my finances stand, as part of the "Reality Finance/Millionaire Challenge".

I generally try to save about 10% of everything that I earn, before taxes. However, it doesn't always work out that way. Sometimes I save less and sometimes I even save more. My savings rate is also affected by upcoming bills that I know I must pay. For instance, if I know that my rent is paid for the month and all of my automatic debits have come out of my checking account, then I can save more than if I know I have a large student loan payment coming out of my account automatically, or I know that I still have to pay the remaining half of that month's rent.

As a solo practitioner lawyer, my income doesn't always come at the same time each month, but it is fairly consistent. I generally earn anywhere between $4,000 to $5,000 per month and this month, I forecast that I will earn approximately $6,000 given my talks with clients who want to retain me and other attorneys who have expressed to me that they need my assistance in various drafting projects.

Yesterday, I made $275, and being that I didn't have any bills coming due immediately, I was able to transfer $40 of it to my Roth Individual Retirement Account, $35 of it to my regular investment account, and I put $110 of it into my savings account. The stock market kind of got slammed today, and so the two stocks that I currently own - and Lockheed Martin - got hit. Not as badly as the broader stock market though. So in total, I lost $14.84, leaving my Roth IRA balance at $1,296.33, and my regular investment account balance at $206.29, for a total investment account balance of $1,502.62. My savings account balance currently stands at $110.

Now that I've gotten that out of the way, it's time to begin to learn everything you need to know about finance. So here we go.

The topics of personal finance and finance generally are all about money. So what exactly is money? 

The Definition of Money

Money is just a medium of exchange. A long time ago, humans used to trade whatever they had in order to get what they needed. For instance, apple farmers used to go to pig farmers to get ham, and the pig farmers would get apples from the apple farmers. This is known as a barter system.

At some point , people decided that always carrying around goods to trade or having to accept illiquid services was inconvenient. So humans came up with the idea that since everyone can agree that gold is pretty, malleable in form, and hard to duplicate, that's what should be used. The gold standard was used for some period of time, but then governments decided to move to a fiat currency system, whereby money is not tied to a physical commodity like gold. A fiat currency system is what every major developed economy uses today. 

What are the benefits of having a currency system that is not tied to a physical commodity? Well, if the amount of money that is in circulation is not connected to a physical commodity, then - you guessed it - money can be created out of thin air. And that's exactly what the government does and is doing as we speak.

In the next blog post, I'll talk about exactly what entity is in charge of monitoring the amount of money in circulation and how it affects you and me on a daily basis.