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What is the relationship between the Federal Reserve and banks

Firstly, here is the quote of definition from the Federal Reserve homepage:

“What is the Federal Reserve System?

The Federal Reserve System, often referred to as the Federal Reserve or simply “the Fed,” is the central bank of the United States. It was created by Congress to provide the nation with a safer, more flexible, and more stable monetary and financial system. Over the years, its role has evolved and expanded.”

What are the Federal Reserve’s responsibilities?

Today, the Federal Reserve’s responsibilities fall into four general areas:

* conducting the nation’s monetary policy by influencing money and credit conditions in the economy in pursuit of full employment and stable prices
* supervising and regulating banking institutions to ensure the safety and soundness of the nation’s banking and financial system and to protect the credit rights of consumers
* maintaining the stability of the financial system and containing systemic risk that may arise in financial markets
* providing certain financial services to the U.S. government, to the public, to financial institutions, and to foreign official institutions, including playing a major role in operating the nation’s payments systems

So, Fed is the central bank of United States. Together with other banks, it is so called a ‘banking system’. There are many interactions between the Fed and other private banks. Generally speaking, private banking businesses are run freely as a profitable business while the U.S. government, through the Federal Reserve System, oversees and regulates the activities of the private banks.

The gold standard

Gold standard is a commitment by participating countries to fix the prices of their domestic currencies in terms of a specified amount of gold. National money and other forms of money (bank deposits and notes) were freely converted into gold at the fixed price.

A county under the gold standard would set a price for gold, say $100 an ounce and would buy and sell gold at that price. This effectively sets a value for the currency; in our example $1 would be worth 1/100th of an ounce of gold. Historically, most currencies were based on physical commodities such as gold or silver. However, the gold standard is not currently used by any government, having been replaced completely by fiat money

Fiat money

Almost every country, including the United States, is on a system of fiat money . Unlike gold standard, fiat money do not have any intrinsic value. It is not linked to any physical reserves. It is used only as a medium of exchange. Recall from the beginning of our discussion about money. In fiat money, the value of money is solely set by the supply and demand for money and the supply and demand for other goods and services in the economy. The prices for those goods and services, including gold, are allowed to fluctuate based on market forces. The amount of fiat money does not limited by the available gold resources in the earth. This is also one of the reasons why the gold standard was replaced.

As you can see, fiat money is based solely on the faith of the government. It is not linked to any physical commodity; it will then have risks of becoming worthless due to hyperinflation. If people lose faith in a nation’s paper currency, the money will no longer hold any value.

George C. (http://www.finance-database.com)