Fiat Currency Backing the Dollar

FiatCurrency: Backing the Dollar

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FiatCurrency: Backing the Dollar

June5th, 1933 marked the end of the United States use of the goldstandard. This was a monetary system whereby currency was backed interms of gold. The Congress then passed an act that was a jointresolution to nullify creditors’ rights in demanding payment in theform of gold. After the nullification, no commodity guarantees thevalue of money. The reason the dollar (or any other currency such asthe euro or the franc) still holds value is due to the establishmentof a stable system where people have known to accept money if theform of pieces of paper in exchange for a valuable commodity. MiltonFreedman, an economist and a noble prize laureate pointed out thatthe dollar bills maintain value because everyone thinks they arevaluable.

Peoplebelieve that a currency has intrinsic value due to the marketplaceforces of demand and supply. The sovereign government maintains thevalue of the currency by spending the money it issues on purchasingcommodities from the citizens who need the money. This sovereignspending helps to accomplish the goal of fiat money transfer to thecitizens’ hands. It also facilitates the creation of commoditiesthe government deems useful. After receiving payment of the fiatcurrency, the citizens start trading amongst themselves using themoney in exchange for goods and services. The need to pay taxnecessitates citizens to deal in this currency. The general feelingis that any citizen in need of paying taxes is willing to receive thefiat currency as payment. In a democracy like the United States, thegovernment that pays its citizens with the fiat currency, it can votefor some things to be built and services to be provided which will bebeneficial to the citizens. Further value of the money is built whencitizens decide to build their reserves in the form of banks wherethey can expand their economic trade among each other and save someof the money every year. Therefore, it is logical for a sovereigngovernment to have substantial deficits in the form of public debt.This represents the amount of money it spends above what is collectedin the form of taxes. This money is equal to the private wealth thatremains among the citizens

Ourcurrency today is referred to as fiat money. This is the type ofcurrency is regulated via the Federal Reserves by the government.Therefore, this currency has no backing system but, only debts. Therelative scarcity of money and the basic faith placed on its value bypeople who use the dollar is what makes it valuable. The governmentdoes not provide any restraints against the creation of any amount ofmoney. This has facilitated the creation of unlimited credit.Normally, credit availability is supposed to spur rapid growth in theeconomy, which is mistakenly seen as economic growth. This is becauseof an increase in spending, increasing profits in business and fastgrowth in prices of equity. However, eventually the economy enduressuffering due to a contraction that follows rather than creditexpansion. Debt/GDP ratio is a clear indicator of credit expansion.The economic issues created by such an expansion can be traced interms of inflation or deflation.

Apublic debt that is in excess leads to the development of a fiatmonetary system in most instances. This is due to the inability ofthe government to repay the debts in silver or gold. The stakeholdersin the government develop temptations to remove any physical backinginstead of defaulting. Such has happened to France during the 18thcentury after enactment of the Law scheme. For the past 300 years,the United States has tried to avoid hyperinflation by oscillatingbetween the gold standard monetary system and fiat currency. This isbecause the terminal stage of a fiat currency is usuallyhyperinflation. Hyperinflation occurs when money has lost valueovernight. It occurs due to increased regular inflation that reachesthe extent where all monetary confidence is lost. Confidence is themost important element in a fiat monetary system and the momentconfidence is lost, money becomes worthless in an irreversible way nomatter how scarce it will continue to be.

TheUS used a fixed gold standard for 76 years between 1785 and 1861.After a damaging period of the fiat, a currency called Continentals,which was used to finance the revolutionary war between 1862 and1879, a fixed gold standard was re-established for 34 years until1914 during the First World War where the government decided to use afloating fiat currency for ten years. The government to pay for thecosts of the war, it had to print a lot of currency in paper form,necessitating its de-linkage from gold. The gold that was availablewas not enough to support the value of money that was circulating.There has been frequent switching between the gold standard and thefiat currency from that period until 1973 when The Basel Accord wasestablished. This enactment is what the country operates on today.

References

Alt,J., D. (2013). The Strange Reality of Fiat Money. The New EconomicPerspective.