Why does fiat money seemingly work?
Posted by LionelHutz 10 years, 10 months ago to Economics
A bit long, but very well written.
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The US Government has only changed its official price of gold 4 times from 1792 to the present. The official US Government price for gold started at $19.75 in 1792. It was raised to $20.67 in 1834, $35 in 1934, $38 in 1972 and finally to $42.22 in 1973.
So even though it was honestly backed (for every dollar in print, there was a dollar in gold in reserve) by something tangible, the standardization of the price of gold (before 1968) was used as a price control to protect against wild swings in the market. Once gold became freely traded, it was no longer possible to back the monetary system with it because you could be in the penthouse in the morning and the outhouse by nightfall.
the first step in de-linking gold from paper, was when Roosevelt outlawed the private ownership of gold and gold clauses in contracts.
In 1792, there were no legal tender laws. so when one talks about the price being "set" by the govt, that did not mean you had to agree to those terms, when not dealing with the govt.
Every government that has had a backed currency was not much better than the fiat system that we have now because of controls on the price of the backing materials. It is the nature of the beast (federalized monetary system). If the government is going to be in the currency business, it must have stability in the underlying pricing to prevent panics, when prices are low, and hoarding, when prices are high.
We would be better off if governments paid their debts between each other in tangible goods instead of paper. We would also be better off if the federal government left the trading at the consumer level to the business owners and their customers.
when a currency is backed by hard asset, it does not flux wildly. ex: the amt of gold in the world does not change wildly, quickly. but the paper can. Gold backed monetary systems are much more honest and stable than fiat. wild flux in prices are the result of govt manipulation in the markets. there is no need for the govt to interfere. it makes thing worse by picking winners and losers. THAT causes panics
Any commodity traded on the open market is prone to price fluctuations due to market conditions, speculation, and even weather reports. The amount of the commodity does not change drastically, but prices do.
For example, when a major gold mine announces that it is shutting down for an extended period, the market usually rises on a perceived shortage even though there is no real change in the amount of gold available for trading. In a truthfully gold backed system this would cause an increase in the value of your currency.
I've taken us down this road of discussion for one reason: "Can we trust the federal government with running the monetary system, even if it is supposedly backed by hard currency (gold and silver)?"
I do not trust govts to do this under any circumstances. Legal lender should be illegal.
There are plenty more examples. The gold price is what fluctuates, while the paper remains the same. Under the post Civil War system, the price of gold was controlled to keep panic selling and hoarding of the paper to a minimum.
Federalized paper money, whether backed by gold or more paper is an abstract representation of value because the government can, and will, manipulate it... or just outlaw owning gold.
In 1933, Executive Order 6102 made it a criminal offense for U.S. citizens to own or trade gold anywhere in the world, with exceptions for some jewelry and collector's coins. Then we had the United States Gold Reserve Act of January 30, 1934 that required all gold and gold certificates held to be surrendered and vested in the sole title of the United States Department of the Treasury.
Gold certificates were again allowed for private investors on April 24, 1964, although the obligation to pay the certificate holder on demand in gold was not honored.
Not until 1975 could Americans, once again, freely own and trade gold.
That's more than several steps backwards.
I don't have any cows to trade for the gas I need....
Before the Civil War, there were tons of local currencies that people used in their everyday lives. Most of these were issued by local banks and were gold and silver at specific weights and could easily be used in different locales. They were not a federal currency. There were federal coins, as well, but most people used the local coinage for their business.
When the federal government outlawed all currencies except the federal currency, all control passed to the federal government and out of the hands of the people.
If the local banker was short-weighting his coins, people would find out and not use his bank, but would go to an honest banker. When these currencies were outlawed, the people had no choice but to accept whatever the government was giving them.