Saturday, September 12, 2009

Fiat gold led to fiat paper

In a Texas Straight Talk posted earlier this year, Ron Paul discussed the meaning of fiat money. "Fiat," he points, is latin for what can be crudely translated as "there shall be." Fiat money is therefore money that exists only because government creates it. It is an entirely different creature than the money that arises on the market, where individuals choose a commodity that best serves the needs of trade to act as a medium of exchange.

As a result of government's fiat paper money, Paul says, Americans have lost "the concept of budgeting." And the government acts like a reckless teenager, with the taxpayers as parents footing the bill.
Every dollar created and spent by government makes the dollars in your pocket worth less and less. Eventually any currency controlled by government will be debased to worthlessness, and will wipe out the savings of the citizens who put faith in that currency.
As Jorge Guido Hulsmann explains in his book, The Ethics of Money Production,
[P]aper money is by its very nature a form of (fiat) inflation. It exists only because of continued legal privileges. It is always and everywhere in greater supply than it would be on the free market, for the simple reason that on the market it could not sustain itself at all. (pp. 160-161)
Many people don't seem to realize that "fiat" applied to the gold standard, as well. What the U.S. and the rest of the world calls the classical gold standard was in fact a fiat gold standard. It was established to serve the interest of the rulers.

Gold had been monopoly legal tender in Britain since 1821; the Coinage Act of 1834 put the U.S. on a de facto gold standard, and Canada and Australia went the same way in the early 1850s. Germany's victory over France in the war of 1870-1871 is usually regarded as the beginning of the classical gold standard.

After the war, Bismarck "set up a fiat gold standard, demonetizing the silver coins that had hitherto been dominant in German lands," Hulsmann writes. (p. 209) Four years later Bismarck turned the Prussian Bank into a national central bank and called it the Reichsbank, thus copying the British model by "combining fiat gold with fractional-reserve banking and a central bank . . ."

Why did Bismarck choose gold and not silver? "[G]old was the money of Great Britain, the country with the largest and most sophisticated capital market. On the other hand, several major silver countries including Russia and Austria had suspended payments at the time of the German victory. Thus, silver offered no advantages for the international division of labor, whereas gold did."

And there was another reason why Germany prefered gold to silver:
Because of its bulkiness, the use of silver entails high transaction costs, which makes it less suitable than gold for fractional-reserve banks trying to quash systematic bank runs through cooperation.

Virtually all other Western countries now followed suit.
The international "unity" in monetary affairs "served as the perfect justification for a further massive intervention of national governments into the monetary systems of the countries." (p. 210)
By the early 1880s, the countries of the West and their colonies all over the world had adopted the British model. [The exception was India, which adopted the gold standard in 1898. Among major countries, only China remained on a silver standard.] This created the great illusion of some profound economic unity of the western world, whereas in fact the movement merely homogenized the national monetary systems. (p. 211)
The homogeneity lasted until 1914, when the central banks decided to suspend gold redemption and print paper money to pay for World War I.

No comments: