Quantum Pranx

This posting contains four separate commentaries

Fiat Money History in the US
http://www.kwaves.com/fiat.htm

OVERVIEW
In a fiat money system, money is not backed by a physical commodity (i.e. gold). Instead, the only thing that gives the money value is its relative scarcity and the faith placed in it by the people that use it. A good primer on the history of fiat money in the US can be found in a video provided by the Mises.org website.

In a fiat monetary system, there is no restraint on the amount of money that can be created. This allows unlimited credit creation. Initially, a rapid growth in the availability of credit is often mistaken for economic growth, as spending and business profits grow and frequently there is a rapid growth in equity prices. In the long run, however, the economy tends to suffer much more by the following contraction than it gained from the expansion in credit. This expansion in credit can be seen in the Debt/GDP ratio. We track the bubbles created by this expansion of debt at the inflation / deflation page.

In most cases, a fiat monetary system comes into existence as a result of excessive public debt. When the government is unable to repay all its debt in gold or silver, the temptation to remove physical backing rather than to default becomes irresistible. This was the case in 18th century France during the Law scheme, as well as in the 70s in the US, when Nixon removed the last link between the dollar and gold which is still in effect today.

Hyper-inflation is the terminal stage of any fiat currency. In hyper-inflation, money looses most of its value practically overnight. Hyper-inflation is often the result of increasing regular inflation to the point where all confidence in money is lost. In a fiat monetary system, the value of money is based on confidence, and once that confidence is gone, money irreversibly becomes worthless, regardless of its scarcity. Gold has replaced every fiat currency for the past 3000 years.

The United States has so far avoided hyper-inflation by shifting between a fiat and gold standard over the past 200 years.

1785-1861 – FIXED Gold standard 76 years
The founding fathers were concerned about the unrestrained control of the money supply. One thing they all agreed upon was the limitation on the issuance of money.

Thomas Jefferson warned of the damage that would be caused if the people assigned control of the money supply to the banking sector.

“I believe that banking institutions are more dangerous to our liberties than standing armies. Already they have raised up a money aristocracy that has set the government at defiance. This issuing power should be taken from the banks and restored to the people to whom it properly belongs. If the American people ever allow private banks to control the issue of currency, first by inflation, then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children will wake up homeless on the continent their fathers conquered. I hope we shall crush in its birth the aristocracy of the moneyed corporations which already dare to challenge our Government to a trial of strength and bid defiance to the laws of our country” –Thomas Jefferson, 1791

Many of the founding fathers experienced the damage caused by fiat currency. Most of the revolutionary war was financed by worthless currency called “Continentals”.

The Continental Currency (“Not worth a Continental”) that American colonists issued for the Continental Congress to finance the Revolutionary War was replaced by the US Dollar in 1785 when The Continental Congress adopted the dollar as the unit for national currency. At that time, private bank-note companies printed a variety of notes. After adoption of the Constitution in 1789, Congress chartered the First Bank of the United States and authorized it to issue paper bank notes to eliminate confusion and simplify trade. The U.S. Constitution (Section 10) forbids any state from making anything but gold or silver a legal tender. The Federal Monetary System was established in 1792 with the creation of the U.S. Mint in Philadelphia. The first American coins were struck in 1793. The U.S. Coinage Act of 1792, consistent with the Constitution, provided for a U.S. Mint, which stamped silver and gold coins. The importance of this Act cannot be stressed enough.

• One dollar was defined by statute as a specific weight of gold.
• The Act also invoked the death penalty for anyone found to be debasing money.

President George Washington mentions the importance of the national currency backed by gold and silver throughout his initial term of office and he contributed his own silver for the initial coins minted. The purchase of The US Mint in Philadelphia, was the first money appropriated by Congress for a building to be used for a public purpose. It was purchased for a total of $4,266.67 on July 18, 1792.

1862-1879 – FLOATING fiat currency 7 years
The first use of fiat money (called Greenbacks) in the United States was in 1862, it was used as a tool to pay for the enormous cost of the Civil War. Greenbacks were a debt of the U.S. government, redeemable in gold at a future unspecified date. They were circulated along with Gold certificates, backed by the government’s promise to pay in gold.

1880-1914 – FIXED Gold standard 34 years
The US dollar was hard pegged to gold resulting in domestic price stability and virtually no inflation. The financial needs of WW1 ended this.

1915-1925 – FLOATING Fiat currency 10 years
In order to “pay” for WW1 countries had to print a lot of paper currency which by necessity mandated a delinking from gold because there wasn’t enough gold to support the paper.

1926-1931 – FIXED Gold standard, 5 years
The gold exchange standard was established wherein each country pegged its currency to the US dollar and British pound which were then supposed to be backed by the dollar. When the depression began countries tried to cash in their pounds and dollars for gold. That “run” on gold forced the end of the gold exchange standard.

1931-1945 – FLOATING Fiat currency, 14 years
Fiat currencies reign worldwide leading to huge economic imbalances from country to country and was of the major contributing factors to the beginning of WW2.

1945-1968 – FIXED – Gold standard, 26 years
1944 Bretton Woods Accord (similar to gold exchange standard of 1926-1931) Two main currencies again, the US dollar and British pound. A run to convert pounds to gold collapsed the pound and began the end of the Bretton woods accord. It took 3 years while governments tried to salvage the system and also to determine what to do next. Kind of like having one leg on the boat and the other on shore. 1963 – New Federal Reserve notes with no promise to pay in “lawful money” was released. No guarantees, no value. This is also the year of the disappearance of the $1 silver certificate. Once again, a subtle shift in plain view.

1965 – Silver is completely eliminated in all coins save the Kennedy half-dollar, which was reduced to 40 percent silver by President Lyndon Johnson’s authorization. The Coinage Act of 1965 signed by Lyndon Johnson, terminates the original legislation signed by George Washington 173 years earlier (carrying the death penalty) enabling the US Treasury to eliminate the silver content of all currency.

1968 – June 24 – President Johnson issued a proclamation that all Federal Reserve Silver Certificates were merely fiat legal tender and could not really be redeemed in silver.

1971 – FLOATING – Fiat currency, 5 months
August of 1971 President Nixon ended the international gold standard and for the first time no currency in the world had a gold backing.

1971-1973 – FIXED – Dollar standard, 2 years
The Smithsonian Agreement was passed pegging world currencies to the dollar rather than gold as a fixed exchange rate.

1973-? – FLOATING – Fiat currency, 30 years
The Basel Accord established the current floating exchange of currency rates we are operating under today.

A good barometer of the size of a currency’s leverage is the percentage of total  Debt to GDP  (Gross Domestic Product). Currently, that percentage (299%) is higher than the level the nation experienced during the depression era 1930′s. With budget deficits projected for 2003 and 2004, the US will soon exceed this already inflated level.

–––––––––––––––––––––––––––––––––––––––––

Fiat Currencies and Gold
From James Turk  http://www.dollarcollapse.com
See also: http://dailyreckoning.com/fiat-currency/

WHAT IS A FIAT CURRENCY?
A currency that’s created and controlled by a government. In other words, it exists by government “fiat.” Using the dollar as an example, the U.S. Federal Reserve creates new dollars simply by printing them or injecting electronic “reserves” into the banking system. The supply of dollars thus depends on the decisions of our elected officials and their appointed administrators like the governors of the Fed.

An example of a non-fiat currency would be the gold and silver coins that used to circulate in much of the world. There was only so much of each metal, and the supply only increased when some enterprising miner discovered and dug up more. Governments were unable to create this kind of money out of thin air.

Like the dollar, today’s euro, Japanese yen, and British pound are all fiat currencies. And—here’s the crucial point—every single fiat currency that has existed prior to the current batch was eventually destroyed by its government.

WHY DO FIAT CURRENCIES ALWAYS FAIL?
Put simply, governments are fundamentally incapable of maintaining the value of their currencies. Every leader, whether king, president or prime minister, serves at the pleasure of two powerful constituencies: Taxpayers irate about what they currently pay and violently opposed to paying more, and recipients of government help who demand vastly greater levels of spending on everything from defense, to roads, to old age pensions. Alienate either group, and the result can be an abrupt career change.

So our hypothetical leader finds himself with two choices, the most obvious of which is to level with his constituents and explain that there’s no such thing as a free lunch. Taxes are the price of civilization, but government largess can consume only so much of a healthy economy’s output, so no one person or group can have all they want. This looks simple on paper, but in the real world it opens the door to challenge from rivals who have no qualms about promising whatever is necessary to gain power.

Not liking this prospect at all, our leader then turns to his remaining option: Borrow to finance some new spending without raising taxes. Then create enough new currency to cover the resulting deficit. The anti-tax and pro-spending folks each get what they want, and no one notices, for a while at least, the slight decline in the value of each individual piece of currency caused by the rising supply. Human nature being what it is, every government eventually chooses this second course. And the result, almost without exception, is a gradual loss of confidence in the value of each national currency, which we now know as inflation.

But a little inflation, like a little heroin, is seldom the end of the story. Over time, the gap between tax revenue and the demands placed on government tends to grow, and spending, borrowing and currency creation begin to expand at increasing rates. Inflation accelerates, and the populace comes to see the process of “debasement” for what it is: the destruction of their savings. They abandon the currency en mass, spending it or converting it to more stable forms of money as fast as possible. The currency’s value plunges (another way of saying prices soar), wiping out the accumulated savings of a whole generation. Such is the eventual fate of every fiat currency. “The Coming Collapse of the Dollar” tells the stories of five of the more spectacular currency crises, but like I said, they all go this way eventually.

WHY WILL THE DOLLAR  be the first of today’s fiat currencies to collapse?
For the past few decades, the U.S. has enjoyed an historically unique position. As the most powerful nation in an increasingly globalized world, its currency, the dollar, is in demand as a store of value. That is, investors and central banks in other countries want to hold dollars as alternatives to their own, presumably less stable currencies. This insatiable demand for dollars has handed U.S. consumers and governments a virtually unlimited credit card. And we’ve spent the past two decades maxing it out.

The U.S. is now the world’s biggest debtor nation, and our current economic expansion is only possible because Japan, China, and Europe are willing to finance our trade deficit by, in effect, lending us $800 billion a year. They do this by taking the dollars we pay for their Toyotas, French wine and Chinese electronics, and using them to buy U.S. bonds and other financial assets.

Add it all up, and U.S. debt now comes to about $45 trillion, or $600,000 per family of four, a clearly unsustainable burden. When our trading partners figure out that we’re no longer solvent, they’ll stop lending us money (that is, they’ll use their dollars to buy euros or yen or gold rather than U.S. bonds), and the value of the dollar will plunge. The process has already begun, with decreasing demand for dollars sending the value of the dollar down by about a third in the past three years. But this is just the beginning.

WHAT HAPPENS when the dollar collapses?
Many things, most of them bad. When foreign investors and central banks stop demanding dollars, U.S. bond prices will fall, which is another way of saying that U.S. interest rates will rise. Mortgage and credit card rates will soar, bursting the housing bubble. Home prices in hot markets like California and New York will fall by 50% or more in a matter of months, bankrupting millions of over-extended homeowners.

The U.S. government will respond by opening the monetary floodgates, printing as many paper dollars as necessary to keep the economy from collapsing. This surge in supply will send the value of the dollar through the floor. Prices for most things will skyrocket, and people whose life savings are in cash, bank CDs or dollar-denominated bonds, will be wiped out. Most U.S. consumer finance companies will be ruined, along with their stockholders.

THEN the Dollar Disease will go global. The only reason Japan or Europe have been able to generate their current meager rates of growth is the willingness of U.S. consumers to buy their Hondas and BMWs. As the dollar plunges, Asian and European goods, priced in suddenly-appreciating currencies, will become prohibitively expensive for U.S. consumers, who will respond by buying U.S.-made alternatives or nothing at all. Correctly interpreting this change in buying patterns as a threat to their vital export sectors, European and Asian leaders will respond with the only weapon they have left: monetary inflation.

They’ll cut interest rates and buy dollars with their currencies, flooding the world with euros and yen the way the U.S. now floods the world with dollars. The result of these “competitive devaluations” will be a death spiral for all major fiat currencies, in which European and Japanese bonds will, eventually, fare as badly as their U.S. cousins.

WHY WILL GOLD GO UP when the dollar goes down?
Until very recently, gold was humanity’s money of choice, for one very good reason: It exists in limited supply, and governments can’t make more of it, so its value tends to be stable. As paper currencies collapse, the world will look for alternatives, one of which is sure to be gold. Massive amounts of global capital will start chasing a very limited supply of gold, sending its value through the roof.

WHY WILL GOLD keep rising?
All the conditions that led to its tripling so far in this decade are still in place. The U.S. and Europe are still borrowing far more than they can ever hope to pay off, and financing the resulting debt with newly-created paper currency. Oil and other commodities are still in short supply, as demand from China and India soars. And almost without exception, the world’s leaders seem unable to grasp the risks inherent in paper currency that can be created in infinite quanties by government.

THREE MORE REASONS:

Gold’s fundamentals are very positive. The world’s mines produce about 2,500 tonnes of gold a year, while demand for gold is currently running about 4,000 tonnes. And new demand from emerging countries like China and India is soaring.

The Fear Index is flashing a “buy” signal. This index measures the financial markets’ anxiety about the dollar and the U.S. monetary and banking system, and in the twenty years since GoldMoney’s James Turk invented it, each of its “buy” signals has been followed by a marked, sometimes spectacular, increase in gold’s exchange rate. Chapter 11 of “The Coming Collapse of the Dollar” explains the Fear Index in detail, but for now suffice it to say continues to point to a rising gold price. Click on “Latest Charts” for the most recent Fear Index chart.

Central bank manipulation is about to backfire. The world’s central banks, led by the U.S. Federal Reserve, have been making up the difference between mine production and gold demand by secretly dumping their gold on the market. They do this by lending their gold for a nominal interest rate to “bullion banks” like JP Morgan Chase and Citigroup, which then sell it and invest the proceeds at higher rates. Because the banks are obligated to return this gold to the central banks, they’re “short” the metal. At some point in the future they have to buy this gold back on the open market. If gold’s price is low, they make money, and if it’s high, they lose. Since it’s currently high and rising, these banks are looking at multi-billion dollar losses. And as these losses mount, the pressure grows to bite the bullet and close out their short positions by buying back their gold. When one bullion bank does this, the others will be forced to follow, producing a classic “short squeeze,” in which all the major bullion banks try to buy at once, sending gold through the roof. For a far more detailed treatment, see Sprott Asset Management’s 70-page report, “Not Free, Not Fair: The Long Term Manipulation of the Gold Price,” available at www.sprott.com. 

Add it all up: favorable demand trends, a Fear Index buy signal, and the coming central bank short squeeze, and the next few years should be spectacular for gold.

–––––––––––––––––––––––––––––––––––––––––

Your Financial Future – Gold and Silver Bullion
http://www.rapidtrends.com/what-does-fiat-money-mean/

WHAT DOES FIAT MONEY MEAN? A fiat money is a medium of exchange composed of some intrinsically valueless substance which the issuer does not promise to redeem in a commodity or a fiduciary money.

Because a fiat money has no direct legal connection to a commodity money (in terms of redemption) and, therefore, no real economic cost to its production, the supply of a fiat money can never be self-limiting; and the value of a fiat money is always largely a matter of public confidence in the economic or political stability of the issuer.

Historically every major fiat money have self-destructed in what is popularly called “hyperinflation” (that is, extreme decreases in purchasing-power) caused by either unlimited increases in the supply of that fiat money by the issuer or accelerating loss of public confidence in the continued value of the money or the economic or political fortunes of its issuer, or both.

The theory and history of fiduciary money (which is also largely the theory and history of banking) must always focus on the ever-present problem of redemption. Emphasis on the noun “problem” is warranted, because a fiduciary money is, by definition, a promise to pay the real, commodity money of the country.

A piece of commodity money – typically, a silver or gold coin – is itself payment because it contains a fixed weight of precious metal. But a unit of fiduciary money – typically, a bank or government-treasury note – is only a contingent and uncertain payment that depends upon the ability or the willingness of the issuer to redeem. And there always exists a temptation for issuers to renege on their promises to redeem.

Thus, fiduciary money always threatens to become fraudulent money. Not surprisingly, therefore, the history of fiduciary money has been more or less the history of monetary fraud, both economic and political. Also, the danger of fraud in the issuance of fiduciary money becomes particularly acute in the case of modern “fractional-reserve banking”.

Under fractional-reserve banking, the bank always issues more units of fiduciary money, supposedly “payable on demand”, than it has units of commodity money available for redemption, counting on the unlikelihood that the majority of its customers will ever seek redemption at one time. Thus, modern fractional-reserve banking is inherently fraudulent, because:

For the bank simultaneously to fulfill all its promises to redeem its outstanding notes “on demand” is impossible. The bank’s managers know that complete redemption “on demand” is impossible, and therefore that the bank’s promises to pay are false. And, the bank’s customers, by and large, are ignorant of how the fractional-reserve scheme works, and the dangers it poses to them.

So I believe it is doomed to fail just like every other time… What is the solution? To store your wealth in something that is not being rapidly devalued, such as gold or silver.

–––––––––––––––––––––––––––––––––––––––––

Fiat Paper Money
by Rep. Ron Paul, MD
Posted originally September 12, 2003
http://www.lewrockwell.com/paul/paul125.html

IN AN ARTICLE entitled “Gold and Economic Freedom,” Federal Reserve Chairman Alan Greenspan wrote that “The excess credit which the Fed pumped into the economy spilled over into the stock market- triggering a fantastic speculative boom…The speculative imbalances had become overwhelming and unmanageable by the Fed… In the absence of the gold standard, there is no way to protect savings from confiscation through inflation.” The irony is that Mr. Greenspan’s words, written in 1966 to describe the era leading up to the Great Depression, could easily have been written in 2003 to describe the consequences of his own Fed policies during the 1990s.

Mr. Greenspan once understood that a fiat money system represents nothing more than a sinister and evil form of hidden taxation. When the government can print money at will, it’s morally identical to the counterfeiter who illegally prints currency. Fiat money polices especially hurt savers and those on fixed incomes, who find the value of their dollars steadily eroded by the Fed’s printing presses.

We need to understand why a fiat system is so popular with economists, the business community, bankers, and government officials. One explanation is that a fiat monetary system allows power and influence to fall into the hands of those who control the creation of new money, and to those who get to use the money or credit early in its circulation. The insidious and eventual cost falls on unidentified victims, who are usually oblivious to the cause of their plight.

Another explanation is that it’s human nature to seek the comforts of wealth with the least amount of effort. This desire is quite positive when it inspires efficient work and innovation in a capitalist society. Productivity is improved and the standard of living goes up for everyone. But this human trait of seeking wealth and comfort with the least amount of effort is often abused. It leads some to believe that by certain monetary manipulations, wealth can be increased out of thin air.

Most Americans are oblivious to the entire issue of monetary policy. We all deal with the consequences of our fiat money system, however. Every dollar created dilutes the value of existing dollars in circulation. Those individuals who worked hard, paid their taxes, and saved some money for a rainy day are hit the hardest. Their dollars depreciate in value while earning interest that is kept artificially low by the Federal Reserve easy-credit policy. The poor and those dependent on fixed incomes can’t keep up with the rising cost of living.

We do hear some minor criticism directed toward the Federal Reserve, but the validity of the fiat system is never challenged. Both political parties want the Fed to print more money, either to support social spending or military adventurism. Politicians want the printing presses to run faster and create more credit, so that the economy will be healed like magic – or so they believe.

Fiat dollars allow us to live beyond our means, but only for so long. History shows that when the destruction of monetary value becomes rampant, nearly everyone suffers and the economic and political structure becomes unstable. Spendthrift politicians may love a system that generates more and more money for their special interest projects, but the rest of us have good reason to be concerned about our monetary system and the future value of our dollars.