May 7, 2011 – Freeread

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.

Read This entire series. Here are the links.