Examining Fiat Money

This entry is part 24 of 31 in the series 2011B

Some may wonder why I have spent so much time dealing with the gold standard and fiat money. The reason is quite simple.

There are two kinds of people in the world as far as economic theory goes. Those who think about how it works and what is the best approach and those who do not, but just blindly accept the crumbs that fall from the table wherever they land.

Unfortunately, the majority of Americans are in the second category. Any economic influence on their voting is very superficial. A meaningless sound bite can influence them if it tugs at their emotional nature. If they lose their job, suffer a pay cut, lose a benefit, hear of a fat cat getting exorbitant pay, see a homeless person or are merely told a certain politician is out to take what belongs to them they will vote accordingly without doing any research into the cause of their grievance.

The first category (the thinkers) is concerned about the economy and at least do a little reading and thinking about how it works and how it could be improved.

A large portion of the students and thinkers of economic theory and how money works are believers in the gold standard and are strongly against most fiat money. Many of these are adherents to the Austrian School of economics which ironically has its strongest supporters here in the United States. They cannot stand even the mentioning of Keynes name and love the words of Mises, Hayek, Rothbard, Ron Paul and others.

Most of these are good people of above average intelligence that have not considered the idea that there are several types of fiat money and it is possible to create a fiat system that brings as much stability as gold and even more prosperity.

Any workable money system has diminished chances of implementation when many thinking people are in opposition to it and it gains added power when a high percentage support it.

I have thus spent considerable time explaining the disadvantages of gold as well as presenting fiat systems of the past which have worked which tells us that we can put together one for the future that can serve us well. Actually this is an understatement. I believe we can put together a system that will bring prosperity that the world has never seen before.

In contemplating this I reflect back to a statement that Bobby Kennedy used when running for President.

“Many people see things as they are and ask why. I dream of things that never were and ask, why not?”

Our world has never had a perfect or near perfect money system, but that does not mean that we have to repeat the mistakes of the past, or even repeat the best of the past. We have the intelligence and the will to create anew a system that is better than anything that has existed before. There is no area of life where a breakthrough advantage is needed more than in our currency system. It hasn’t improved much in over 3000 years so it is about time for progress to be made.

Creating a better way was the attitude of the Founding Fathers when they founded this Republic and its Constitution. They didn’t just take the best of the past and recreate it. Instead they took the best working elements of past government and added new elements to create a government that was “a dream of things that never were.”

I don’t expect a lot of gold standard people to accept my writings right away but a few will at first and more will follow. If these ideas circulate among them they will be forced to discuss them logically without first just dismissing them as Keynesian or doomsday economics. In addition I hoped to reach many who do not have set opinions who can see the reasoning in that which I present.

First let us examine some of the problems many have with considering the use of fiat money.

Objection 1: Fiat money is not backed up by anything. It is created out of thin air. Real money is composed of metallic coins or is paper backed up by a commodity, preferably gold or silver.

Answer: This conclusion is not exactly true. If one only looks on the surface it may seem that fiat money is created out of thin air with no backing but such is not the case. If the dollar were really backed by nothing then it would be worth exactly nothing. This is obviously not the case because we purchase groceries, clothing, pay mortgages, buy cars and many other things with fiat money.

Our money obviously has value. Where does this value come from?

The most common answer is faith – pure faith. If one thinks about this answer he can soon conclude that this is far from the correct answer. Let me illustrate. If we find a person with no faith in the dollar and send him to the store to buy some bread does his zero faith take away value from the money so he cannot buy the bread? No. Even though he has no faith in the money the value is not diminished. His money will purchase just as much as the guy with lots of faith in the dollar.

If faith does not create the value then what does? Aristotle brings us closer to the answer. He stated:
“…Money exists not by nature but by law….There must then be a unit, and that fixed by agreement.”
Aristotle (Ethics, 1133)

This gets us closer to the truth. Money is created by law through a fixed agreement. This seems more reasonable than faith alone but it doesn’t give the full story. It doesn’t explain why fiat or any other kind of money has value.

If we could just create money by passing laws and making agreements then let us all agree that everyone will receive a million dollars in money each year and there will be no inflation.

We all know that would not work, don’t we?

Faith, law and agreements are all ingredients that help create the power of money, but what is the core principle? What gives a fiat dollar its purchasing power?

The answer lies in this question? What gives a gold backed dollar its purchasing power?

It’s gold you say? But what produced the gold?

It was human labor.

Money has also been backed by many other commodities such as houses, wheat, tobacco and Indian Wampum. What produced these products?

Adam Smith explains:
“Labour alone, therefore, never varying in its own value, is alone the ultimate and real standard by which the value of all commodities can at all times and places be estimated and compared. It is their real price; money is their nominal price only.

Labour … is the only universal, as well as the only accurate, measure of value, or the only standard by which we can compare the values of different commodities, at all times, and at all places … By the quantities of labour, we can, with the greatest accuracy, estimate it, both from century to century, and from year to year.”

Labour was the first price, the original purchase – money that was paid for all things. It was not by gold or by silver, but by labour, that all wealth of the world was originally purchased.
Adam Smith The Wealth of Nations, Book I, Chapter5

Benjamin Franklin agrees with this: “The riches of a country are to be valued by the quantity of labor its inhabitants are able to purchase, and not by the quantity of gold and silver they possess.

“All wealth is the product of labor.”
John Locke

“Labor is prior to, and independent of, capital. Capital is only the fruit of labor, and could never have existed if labor had not first existed. Labor is the superior of capital, and deserves much the higher consideration.”
Abraham Lincoln

Thou, O God, dost sell us all good things at the price of labor.
Leonardo da Vinci

The bottom line is that money has value not because of any commodity, faith or law alone but because it is backed by labor and that which labor produces.

If I give my neighbor my word that I will mow his lawn tomorrow then that is as good as giving him the $20 (or more) he would have to pay a mowing service. It is also as good as $20 in gold, silver or wheat. I created this value seemingly out of thin air by the fiat of my word alone; but was the value created from nothing?

Not exactly. My word in this matter only has value because my labor has value. Labor does not come out of thin air but is energy guided by constructive intelligence.

Conclusion: Fiat money and commodity money both trace back their value to one source: human labor.

Copyright 2011 by J J Dewey

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Copyright 2011 by J J Dewey

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