To Fiat or Not Fiat

This entry is part 13 of 31 in the series 2011B

Okay, says the critic, gold and silver money (or commodity based money) is not perfect but it is a lot better than fiat money. Your fanciful parable sounds good but in actual reality fiat money has always led to disaster. Just look at the current debacle with our economy, which is based on fiat money. Do we want to create just another version of what we have now? I don’t think so.

The problem with this point of view is one has to accept a number of misconceptions to embrace it. Among them are:

(1) There were halcyon days in the past we can point to when there was no fiat money where the economy was stable.

The Reality Is: In all the history of the United States where any semblance of civilization has existed there has been fiat money or thin air money. This also applies to most of the history of the civilized world.

What is a good example of a period where there was no fiat money?

The darkest of the dark ages – not too good of an example.

(2) All fiat money is the same and equally bad, or nearly so.

The Reality Is: There is a huge difference in different types of fiat money and they all produce different effects.

There are two main divisions of fiat money which are:

(A) Money created by private banks or institutions and loaned out at interest. Most of our national debt is created this way. The Federal Reserve creates the money by fiat and loans it to the government at interest.

(B) Interest free money created by the government.

When one considers that we are paying over $450 billion just on interest per year then the advantage of the second type become blatantly obvious.

The last time we have created the second type of fiat money was in the creation of the Greenbacks by Lincoln during the Civil War. Since then all fiat money fits in the first category.

In the past century the banks have had a monopoly on fiat money, but there have been numerous examples in history where interest free fiat money has been used quite successfully. We’ll be elaborating on these.

In addition to the four main categories there are two subcategories of fiat money.

The first category is pure fiat money decreed to be legal tender by law but neither tied to or backed up by any commodity.

Since Nixon took us off any semblance of the gold standard in 1972 this is the type of money the United States and most of the world has had

The second type is money that has its value set by gold or some other commodity, but is not redeemable by anyone. The commodity such as gold merely determines the value of various bills. Ancient China used this method.

The third is where the value of the money is set by a commodity and can be redeemed by other banks institutions and nations, but not by individuals. This was the type of money the United States used from 1933-1972.

The fourth is usually called fractional banking rather than fiat money creation. This is where more than the value of the commodity, usually gold, is placed in circulation. The money can be redeemed in gold by all including private individuals. The amount of money created from a dollar’s worth of gold may range from $4.00 – $10.00, but many unscrupulous banks used a higher ratio – sometimes going up to 1000 to 1.

If a bank creates ten dollars for each dollar’s worth of gold then $9.00 of that is only backed by thin air and it can be argued that this money is as fiat as money can be. If all the banks’ customers come to redeem their money for gold then only the first ten percent would receive anything. 90% would get nothing.

During the entire history of the United States from colonial times until the present there has always been some type of fiat (or thin air) money in circulation. Those who advocate that we return to the past where we had a pure gold or silver standard just do not know their history. We have never had such a standard. For the purest possible gold standard we would have to go way back to the dark ages.

There are a number of views on the ideal money but what the idealist rarely admits, when defending his view, is there is a common flaw that has adversely affected money of every type throughout history. That flaw should be obvious to all and needs to be encapsulated.

Money is power and power corrupts. Unless checks and balances are put into place a large percentage of those who are in charge of the money will abuse their power for selfish gain – even at the expense and suffering of their customers and their nation.

This problem, an offshoot of human weakness, threatens all money whether it be fiat or gold backed, whether it be private or public, whether the basic system is sound or unsound.

Are we doomed then to be forever, manipulated by unscrupulous money managers? Should we just throw our hands up and give up?

Of course not.

What shall we do then?

The first thing is to create the soundest most beneficial money system. This is essential, for without a sound system the economy will stagnate even with honest people in charge.

The second is to not place blind trust in any central, regional or local authority who has power over the money supply or storage. The power to create or borrow money that places taxpayers at risk must be held in check by the people or some other means.

If these two points are realized then a sound money can be had by all and there is no reason that an optimum system will not last as long as the nation does. In fact a good money system will strengthen the nation and extend its life.

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Copyright 2011 by J J Dewey

Copyright by J J Dewey

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1 thought on “To Fiat or Not Fiat

  1. JJ
    Okay, says the critic, gold and silver money (or commodity based money) is not perfect but it is a lot better than fiat money. Your fanciful parable sounds good but in actual reality fiat money has always led to disaster. Just look at the current debacle with our economy, which is based on fiat money. Do we want to create just another version of what we have now? I don’t think so.
    The problem with this point of view is one has to accept a number of misconceptions to embrace it. Among them are:
    (1) There were halcyon days in the past we can point to when there was no fiat money where the economy was stable.
    Blayne
    This is a mis-characterization. Of course there has almost always been fiat money however when ever there have been periods of sound money and free-markets in currency they led to a stable and prosperous economy. 19th century America is a good example. With a free market in currency in other words no monopoly enforced on any currency by government fiat the economy remained relatively stable and prosperous along with the dollar (silver, which by the way predates the constitution) despite the abuse it took during the civil war and the only time problems arose is when the rules of sound money were violated and the the currency debased by fiat or otherwise. This continued right up to 1913. See Murry Rothbard’s A History of Money and Banking in the United States… http://mises.org/books/historyofmoney.pdf

    JJ
    The Reality Is: In all the history of the United States where any semblance of civilization has existed there has been fiat money or thin air money. This also applies to most of the history of the civilized world.
    What is a good example of a period where there was no fiat money?
    The darkest of the dark ages – not too good of an example.

    Blayne
    The reality is this is another false argument. I am not sure understand the definition of fiat money. There have been plenty of times in history when one currency over all others was not enforced by government fiat such as 19th century America among others… Paper currency was prohibited in the constitution precisely because of the continental dollar fiasco which by the way was interest free fiat money that left the new nation in stifling debt forcing them to abuse their new taxing power and acquiesce to British banksters for loans leading to the war of 1812. It has always been paper money that has led to monetary problems debasement and monetary collapse.

    JJ
    During the entire history of the United States from colonial times until the present there has always been some type of fiat (or thin air) money in circulation. Those who advocate that we return to the past where we had a pure gold or silver standard just do not know their history. We have never had such a standard. For the purest possible gold standard we would have to go way back to the dark ages.

    Blayne
    Neither I nor anyone here who has debated with you on this topic have ever said there was a pure gold standard as you describe. So this argument is moot. However their has been a PM standard through out history. America from colonial times until 1972 has had some form of PM standard. Pre revolutionary war times in America are a great history of the failure of fiat currencies and how returning to a PM standard stabilised those economies and prices rather quickly after a short adjustment and with less pain then anticipated and then developing more prosperity then when the fiat was in effect in supposedly expanding the economy and eliminating the boom bust cycles. Again See Murray Rothbards book it is a free PDF and must reading: http://mises.org/books/historyofmoney.pdf

    Fiat money for economic growth is akin to saying charging up your credit card makes you wealthy. One can live well on a credit card for a while and indeed appear wealthy however it is an illusion. Todays crumbling economy is living proof of what debasing the currency does. Fiat money interest free or not will depreciate and need to be inflated driving up prices. As I said inflation is the life blood of fiat currency however its lifespan is always short lived. No more the about 40 years or so historically. People look back to pre 1933 times nostalgically and the vast difference in prices today compared to then totally oblivious that this is due precisely to fiat currency and that even if it was interest free government printed it would make no difference what so ever except that it would have probably depreciated even faster.
    JJ
    B) Interest free money created by the government.
    When one considers that we are paying over $450 billion just on interest per year then the advantage of the second type become blatantly obvious.
    The last time we have created the second type of fiat money was in the creation of the Greenbacks by Lincoln during the Civil War. Since then all fiat money fits in the first category
    Blayne
    Of Course Lincolns greenbacks is always trotted out as a successful system of interest free fiat money and touted as better then sound money and the saviour of all our monetary woes if something similar could be implemented.
    The reality is that as with all fiat monies it began to depreciate immediately and then had to be inflated to compensate which of course drove up prices and invoked Gresham’s law driving out gold and silver specie leaving us in a severely inflated and debt ridden economy after the war. This probably needs a whole article itself. Which I may do if I have time. Here is an excerpt from the above mentioned book:
    “The total money supply of the country (including gold coin,

    state bank notes, subsidiary silver, and U.S. currency includ-

    ing fractional and greenbacks) amounted to $745.4 million in

    1860. By 1863, the money supply had skyrocketed to $1.435

    billion, an increase of 92.5 percent in three years, or 30.8 per-

    cent per annum. By the end of the war, the money supply,

    which now included national bank notes and deposits, totaled

    $1.773 billion, an increase in two years of 23.6 percent or 11.8

    percent per year. Over the entire war, the money supply rose

    from $45.4 million to $1.773 billion, an increase of 137.9 percent,

    or 27.69 percent per annum.113

    The response to this severe monetary inflation was a mas-

    sive inflation of prices. It is no wonder that the greenbacks,

    depreciating rapidly in terms of gold, depreciated in terms of

    goods as well. Wholesale prices rose from 100 in 1860 to 210.9

    at the end of the war, a rise of 110.9 percent, or 22.2 percent per

    year.”

    A History of Money and Banking in the United States
    Before the Twentieth Century
    – Murray Rothbard

    JJ
    There are a number of views on the ideal money but what the idealist rarely admits, when defending his view, is there is a common flaw that has adversely affected money of every type throughout history. That flaw should be obvious to all and needs to be encapsulated.
    Money is power and power corrupts. Unless checks and balances are put into place a large percentage of those who are in charge of the money will abuse their power for selfish gain – even at the expense and suffering of their customers and their nation.
    This problem, an offshoot of human weakness, threatens all money whether it be fiat or gold backed, whether it be private or public, whether the basic system is sound or unsound.

    Blayne
    Where did this come from? I have consistently made human weakness and corrupt central monetary management a cornerstone of my argument and observed others who have debated you on this do the same. I am still waiting for your solution to this problem.

    I have offered the solution and that is to put it back in the hands of the people in the historically proven free market on currency which has worked every time it has been in effect. Eliminate central monetary management as it is unnecessary and has led to disaster every-time in history. I am also waiting on you to point to a successful fiat system in history. Last time you tried to pass that little British common wealth island (I forget the name) off as such but a little research showed otherwise.
    JJ
    Are we doomed then to be forever, manipulated by unscrupulous money managers? Should we just throw our hands up and give up?
    The first thing is to create the soundest most beneficial money system. This is essential, for without a sound system the economy will stagnate even with honest people in charge.
    The second is to not place blind trust in any central, regional or local authority who has power over the money supply or storage. The power to create or borrow money that places taxpayers at risk must be held in check by the people or some other means.
    If these two points are realized then a sound money can be had by all and there is no reason that an optimum system will not last as long as the nation does. In fact a good money system will strengthen the nation and extend its life.

    Blayne
    Who is throwing up their hands and giving up? We agree on creating a sound money system but disagree on what that is. We also agree we cannot trust any central authority. You say the solution is with the people. I agree and again point out that the solution is simple; a free market as has been explained, and proven in history. The people can manage their own monetary affairs without government intervention and history has shown they will prosper when freedom prevails. This is the only proven check on the monetary system that maximizes freedom and minimizes corruption and leaves the power where it belongs; in the hands of the people! Governments only role in the matter is to protect freedom and our right to free trade, not to intervene and try and manage it.

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