Fiat Money, what's the Punto?
As a guess, I would say that when most people hear the word ‘Fiat’, they think of a car, a Punto or maybe a Brava.
We all know that certain professions and businesses enjoy mystifying people with confusing jargon. One that I have seen emanating from the finance community recently has been the phrase ‘fiat’ money. Whilst this seems somewhat innocuous, it’s actually pretty fundamental to the world in which we live and could play a pivotal role in some changes taking place around us.
So what is Fiat Money?
Simply speaking, it derives its meaning from Latin and means ‘Let it Be’.
How can that possibly relate to money?
Imagine someone holding up a piece of paper and declaring, ‘this is money’, well now it is money. The person has spoken and now we must regard it as such. In this case the government has printed paper money, given it value and we are told not to question, just let it be.
Why is this relevant?
To understand, try and answer the following question; what is the odd one out of these types of money: cattle, commodities, silver, gold and paper?
All have been used as forms of currency for thousands of years in various civilizations. Some have value through utility - cattle were useful for feeding the family, or scarcity - silver and gold were extremely rare and hard to mine. The odd one out, as you probably guessed, is paper money.
It is the variant because it has no value in and of itself. Despite having no value through either utility or scarcity, the reason it can work is; firstly, that everyone accepts it as form of currency and secondly, the government decreed it illegal to counterfeit, controlling its scarcity.
So we have an accepted means of currency that facilitates trade and thats value is controlled, through scarcity, by the government so that you cannot setup shop with a bundle of paper and a printer and make yourself a millionaire overnight.
Scarcity, the natural boundary...
The government created scarcity through counterfeiting laws and in theory this system could work, were it not for one fatal flaw. To understand this flaw, it helps to take a look back through history.
For thousands of years, Kings and Queens have sought out war to protect borders, build wealth and seek glory. In these authoritarian regimes there was but one shackle, the ability to finance these expensive ventures. Funds were typically raised through taxation which, unsurprisingly proved unpopular with the people.
Gold and silver coins, or even cattle, couldn’t be created out of thin air to fund military campaigns, so the availability of money restrained wars naturally, through the laws of value.
War could only be waged so far as the wealth of a nation would allow it. Eventually, the money runs out and the soldiers go home. This is the beauty of scarcity and true value.
So how does this relate to fiat currency?
In the modern world counterfeiting laws create scarcity but the flaw is in the exception.
Governments and Central Banks still allow themselves the ability to print (or counterfeit) money, quantitatively ease and create credit. No one else is allowed to do this, but they can. They who said ‘Let it Be.’
In this system, there is no shackle or natural bound of scarcity to limit our Governments or Central Banks. At present our leaders can create currency at will, wage wars, fight battles and pursue their agendas freely, without having to worry about direct taxation of the people.
Fiat currency is a system where it is decreed that something of no value, a piece of paper, has value and we use it to go about our daily trades. In and of itself this can work, but without the natural restraints of scarcity and utility, it is open to abuse. If a party has the ability to create currency without having to generate economic value in return, the currency can be debased, which is exactly how fiat currencies are structured.
In a world where money translates to power this is a potentially dangerous setup. Governments and Central Banks, who control the only source of currency creation, are effectively able to generate currency out of thin air for pursuits they deem fit.
Isn’t it good if governments have an endless supply of money?
Endless money would be great, sure the government could print billions legally and give it to the people, making us all rich, no?
Unfortunately, the laws of value don’t allow this. As currency is created, it takes value from the money that is already in circulation, that is the money you hold in your bank accounts. That $10 note suddenly became worth only $9.95 when that first billion was printed and that has continued to this day, as more and more has been printed over the years.
In fact, if you were to track the value of the dollar since it was freed from the natural bounds of the gold standard, you can see that the value today hovers around $0.05. Frightening to think we generally consider our savings safe when held in the bank!
To be clear, the above does not represent a destruction of value, rather a redistribution of value. The value from one dollar has been taken to create new dollars, dollars that go out of
your pockets and into those of whom ever the government chose.
This stealth tax removes the resistance faced by historic monarchs and governments, when taxing the people to finance grand ventures and is only made possible through the use of fiat currency.
The worst thing about this process is that it happens whilst you are sleeping, without your knowledge but in plain sight. The process of inflation is talked about as if it is something we need, something good for a growing economy but in reality it is the side effect of your money seeping its way out of your bank accounts and into the hands of politicians and bankers.
When it comes to your money, beware he who says let it be.
Be it to us all, then it can be. Be it not to us all, then let it be not.