Value of Currency, Gold vs. Fiat; The Genuine and Spurious

A Chronological look at the history of Currency and the emergence of Fiat Money

This article was originally published in Data Driven Investor

Photo by NeONBRAND on Unsplash

Money is a verifiable document commonly admitted as payment for goods and services or repayment of debts. It functions as a standard of exchange, a unit of account, a reserve of value, and seldom a deferred payment standard. For the economist, money is an economic unit that works as a generally recognized medium of exchange for transactional purposes. Money makes the world go around. Even though a document or paper’s value as worthless as a piece of paper was once considered the representation of another fictitiously valued commodity, i.e., Gold, nonetheless, it backs even more fictitious things that don’t have an external existence but are even more imaginary, called Fiat money.

As the backing of the monetary value, such as precious metals, including Silver and Gold, go back to human civilizations’ advent, U.S. monetary policy was also initially founded upon a bimetallic (Silver and gold) dollar. Between 1792 and 1834, the United States currency was on a silver standard. Except for California and Oregon, where a gold standard continued to operate, from the Civil War era until 1879, a fiat “greenback” standard predominated the United States economy. Greenbacks were “Fiat” paper currency printed in green on the back of the dollar bills issued by the United States government. They were legal tender and, unlike Gold and silver, backed by the “credibility of the U.S. government.”

The Gold Standard of Currency

In an actual gold standard, the primary monetary unit is backed by the specific weight of Gold (or any precious metal) alloy of particular purity or equivalent in fine Gold, and prices are expressed in the unit or some fractional units upon it. Cash is a government monopoly; the government offers to convert gold bullion into “full-bodied” gold coins, serving either the standard company; itself or multiples of fractions thereof, in unlimited amounts. This policy of providing for the complete issuing of gold bullion is known as “free” coinage. Thus, money is created through public demand to convert bullion to coin. Between 1870 and 1879, numerous countries incorporated gold monometallism. After that, it also began the era of the Gold Standard in the U.S.

The Traditional Gold Standard era lasted until World War I when countries started abandoning their commitment to convertibility. Post-World War II, the Gold Exchange Standard was replaced by the Bretton Woods System and its dependence on a fiat dollar. Bretton Woods finally became official when President Nixon closed the “gold window” on August 15, 1971.

Because commodity money (e.g., Gold) is based on a physical product, it is less prone to inflation from the money’s devaluation. Gold is relatively finite money, and the government cannot create more whenever they want to, thus lessening inflation.

Commodity money, such as the Gold standard, has an inherent value based on its physical properties such as Gold, oil, and silver.

Commodity monies can devalue over time, such as oil, barley, or olive oil. They have a shelf life, and once they extend past that lifespan, hence they devalue.

The Concept of Fiat Money

Fiat money is a government-founded Currency without intrinsic value. It means that the cost of fiat money is independent of any nominal value gold and silver may have or be backed up by a commodity. But it represents a claim on a thing that can be redeemed to a greater or lesser extent.

China was the original country to use fiat currency around 1000 AD, until more recently, in 1971, when Richard Nixon seized the U.S. off the gold standard. Today, most developed states use some form of fiat money as their means of payment. For fiat currencies to be productive, the nations must control counterfeiting and refrain from abusing the supply of cash.

Fiat money is as valuable as the confidence in the people that give it its value. Unlike money backed by goods, fiat currency authorizes the central banks indiscriminately to print or hold money with the excuse of helping control the money supply, inflation, interest rates, and liquidity. Although that may be the original intention, however, when we incorporate politics and bureaucracy into economics, the outcome becomes completely different. Fiat money has no expiration period other than the corrupting of the real money used over the system. It manipulates and controls inflation by rectifying the interest rates and generating more or less money in the design, hence intentionally meddling into the value of sweat and blood-earned money. And Since the amount of fiat money is somewhat tied to the government, its value is as transparent as its administration.

Fiat money is the modern monetary system. It can potentially change. One such change can be towards a different commodity than we are historically acquainted with: the rise of a data-driven currency such as Bitcoin.

Fiat money is hypothetical money and is none liberating to citizens. It is ridden with flaws exposed many times in history. The most recent example is the Covid-19 pandemic that has uncovered our current fiat monetary system’s shortcomings. That was done by compelling the Federal Reserve to open its piggy bank and spill out all the money it could to keep the country’s economy alive with no apparent success.

Fiat Money is Manipulated thru Credit Extension

The time of replacing the Gold standard with fiat currency, U.S. dollars, has been backed by the “credit.” It is the “legal tender for all amount outstanding, be it public and private,” but not “exchangeable in lawful money at the United States Treasury or any Federal Reserve Bank.” Therefore, U.S. dollars are now “legal tender,” rather than “lawful money,” which can be exchanged for Gold, silver, or any other commodity.

Fiat currency is Credit and not Money

According to Carlos Bondone’s monetary theory, in contrast to regular Currency backed by a commodity, fiat cash is an Irregular credit currency. Debt is not specified and does not have predefined quality, quantity, or due date. That needs to be further explained to understand it fully.

If it is not money currency, then it must be credit!

In Regular Credit Currency, the current good that cancels the debt is specified, and so is its quality, quantity, and due date. That is the case for bank bills redeemable for Gold or silver. In Irregular Credit Currency, on the other hand, the present good cancels the debt is not specified or its quality, quantity, or its due date. That is the case for today’s currencies, such as dollars or euros. Based on the latter definitions, there is a need to find a way to discern between present economic properties and forthcoming economic goods and the need to define a credit. Fiat currency falls into the category of future financial interest because it is issued under the issuer’s final obligation to be accepted to write off debts with the issuer in the future. By definition, all debts are future goods.

Moreover, fiat currencies are registered today within the issuers’ financial statements by recording their liability and backing it with an asset that reflects its credit nature. Therefore, the market, not the state or legal tender laws, values fiat currencies by delivering present goods (labor, services, commodities) in exchange for future things (fiat currency). Value inflation and currency repudiation are clear proofs of this conclusion. Any agent that holds fiat currency, i.e., the government, is a creditor of the banking system. It is always subject to credit risk and counterparty risk (Government and banking system). Hence, The Central Bank is not the lender of last resort but the first instance debtor.

Interest Rates and Fiat Money

The government policies persist in being overseen by confusion between causes and solutions, a repudiation to accept responsibility for problems in the economy, and a preoccupation with spending and stimulus money. The consequences of state intervention in the monetary and financial system are profound, highly destructive, and often unpredictable.

Proponents of government intervention maintain that pushing down interest rates is virtuous for the economy because it boosts investment and increases asset values. They believe that by doing so, the government promotes confidence and encourages more lavish spending, which oversees further economic expansion. But lower interest rates have over and over been responsible for one boom-bust cycle after another since the late 1990s. Each time the government responds to the bust has been to lower interest rates creating an even more giant bubble next time.

Fiat Money Redistributes Wealth

In the new fiat money system, central banks relentlessly increase the quantity of money through credit expansion in close coalition with commercial banks. They extend credit and thus issue new money, created out of thin air, not backed by actual savings. Naturally, the new money receivers are the beneficiaries who can exchange their new money against goods and services at unchanged rates. However, As the new money is passed on from hand to hand, and the demand for sensible items goes up, demand will drive up the prices under demand. Hence, the late receivers of the new money can only buy at already elevated prices. As an outcome, the new money’s early receivers’ wealth goes up at the new capital’s late receivers’ expense. Unlike the open free market, the issuance of fiat money creates winners and losers. In a free-market economy, people trade voluntarily, and both parties benefit from such a transaction. There is no escape from this strongarm rearrangement of income and wealth in the fiat money as governments have monopolized money production. Therefore, in such a scenario, People have no choice but to use the governments’ fiat money.

Credit line and Politics of Fiat Economy

In the economy based on credit, it is expected that prerogatives over economic possessions to take distinct forms where the credit market has presumed a more significant position in determining the lifetime probabilities of individuals relative to the labor market. This expectation reflects a fundamental difference in how associations between parties to exchange is authorized in the credit and the labor market. Typically and in a free market economy, the earnings relationship leans on formal equality between parties to interact. However, much of this legal equality is subject to the violation of the association’s substantive content. In contrast, the credit relationship represents the inequality between parties to exchange; meaning, the creditor looms over the borrower, positioned to bestow credit or deny it. In contrast to the quid pro quo exchange that characterizes the wage relation, the extension of credit creates an obligation that, as long as it is unreciprocated, marks the debtor as inferior to the creditor.

Fiat money is a monopoly because of the close relationship between financial systems and the government’s nature built around the non-commodity monetary structure.

Many economists have recognized that fiat money is the prerequisite for authoritarian government and that monetary interventionism paves the way for despotic government. So, the government must be financially dependent on the citizens. Once in office, elected politicians turn around and act differently than they promised and perversely to their constituents’ common good and interests.

The way we control government is by way of restricting the budget. That is necessary for a free society. The fiat money empowers the government just by delivering the opposite.

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