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September 17, 2011

What Is FIAT Money?

Fiat moneyWhen FIAT automobiles were less than reliable, some wag came up with: "Fix It Again Tony!"
Is FIAT money: "Fix It Again Tim?"


Humanity invented money to replace barter with more efficient trade. Ever since day one money has been managed, mismanaged and abused. The only real benefit of gold as money is that counterfeiting is made more difficult. But gold as currency is a PITA. The gold standard was a good compromise: paper as currency with the paper backed by gold. But as soon as fractional reserve banking was invented, the gold standard became an illusion. You take $100 worth of gold to the bank and get 100 pieces of currency. The bank then lends someone, say, 80 pieces of currency. Now there are 180 pieces of currency circulating but backed only by $100 worth of gold. This is legalized fraud. As long as depositors think they'll get their money back, the fraud can continue.

Money Is Nationalized

Governments provide certain services that markets cannot provide and these services are paid by taxes, levies and user fees. At some point governments decided to nationalize and monopolize money. The money the government prints is no more or less real that the money that markets used to create. The only reason government money ousted private money are the so called "legal tender" laws. With every other merchandise you are allowed to test for quality and accept or reject it at your sole discretion. Not so with legal tender, you have to take it no matter how crappy you think it is. Your only consolation is that you can pass off this money when you pay taxes.

An Unwholesome Alliance

The system works well enough until the bankers go crazy and reserve requirements go out the window. Bankers can do this because governments go along using the extra fake money to create social programs like buying houses by people who don't have a prayer of ever paying them off. Necessarily the system blows up as it did in 2008. Unfortunately, the government learned that you can extend the charade as long as you create the illusion that banks are solvent. It's really simple: You print up fake money to buy worthless assets at full face value. If the Fed had to mark-to-market, it would be broke, but no one is allowed to audit the Fed.

Whither Money?

The inevitable consequence of this money printing is runaway inflation. Why has it not happened yet? Because money is like water, it has to move to generate power. A huge lake full of water is potential energy. But to convert the potential into usable energy you have to let the water flow over a dam and fall some distance to drive turbines.* Corporations are warehousing money. Even though the money is reported as "circulating assets" in fact, for the time being, it has become a fixed asset, a lake of money. As long as the Fed keeps interest rates low, as long as inflation is under control, this lake of money does not lose too much of its potential. But what happens when the dam breaks? What happens when the companies decide to put the money to good use? The fixed money goes back into circulation chasing a limited amount of goods pushing up their price. In a word: "Inflation."

That's the story of FIAT money.

Denny Schlesinger

* The power comes not from the water but from sunshine. It's a long story but don't let it confuse you.

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Last updated March 8, 2009.