The US government lending Spree that started in the beginning of the 1990 were the US government created Fanny/Freddie (among others), is deemed by many as economists as a root cause of our current economic crisis.

I would say that Alan Greenspans actions in the 2000’s is aftermath that kept it racing in the wrong direction, but this crisis was not created during the past 10 years, but rather in the past 20 years.

Fiat currencies, they have been around since the first wave of globalisation (the colonial powers created them), and the real big change was when Bretton Woods was abandoned (-71), and was part in creating the very volatile gold markets in the 70-ies.

What would be the alternative? All currencies that are freely convertible/traded are by definition fiat currencies, and an effect of global trade.

They are traded against each other, so if you increase circulation, you will loose comparative purchasing power against the other global currencies, thus keeping a balance in the global markets (there is one exception though, see below). They makes the fiat currency a commodity with scarisy as any other (as increasing circulation/printing more money will be costly).

If you would describe a closed economic system (with a restricted/non-convertible currency) such as the Soviet Union was or some countries in the world today, scarcity would not be as balanced.

There is hardly any alternative, but fiat currencies is harder to value than currencies that are convertible to gold (as for example the US dollar was until 1971, when Bretton Woods were abandoned) as with a majority of the things traded on markets today, you never know if it’s lemon….

Which is the problem with fiat currencies, a fiat currency can be very sound, with-out a large reserve, but it’s hard to assess if it’s sound or a lemon.

The US Dollar have had a development were it was kept very low for a long period of the 2000’s, the odd thing is that the international purchasing power in the US have been very competitive (the same new Japaneese car would cost more than twice as much in Sweden compared to the US), so the US enjoyed the benefit of the low dollar, but not the loss in purchasing power (for some things yes, but for many not at all). I think this is due to the fact that the US economy constitutes 30% of the wold GDP, and many currencies are pegged to it and a majority of trade agreements have been dominated in US Dollars.
This fact have tilted the market dynamics in the favor of the US, but now we are seeing a backlash, were the US Dollar has been pressed up in value, and other lost in comparative value. This is probably a sound reaction. I would not bet my money on the US dollar being as strong as today, but it will not go back to mid 2008 levels either I think.

2 replies
  1. Wille
    Wille says:

    The problem with fiat currencies isn’t whether they are sound now or not, the problem is that they are so easily manipulated and lack transparency, something that has been going on ever since their inception (the US Federal Reserve refuses to publish any numbers on money supply these days, and the Bank of England are taking similar steps).
    When authorities take every step to obfuscate and obstruct, you can be pretty sure that they are up to no good.
    In a crisis, you can be sure that politicians will panic and manipulate money supply numbers for the sake of political expedience.

    Secondly, a currency that is not anchored in anything will result in wealth distribution that does not reflect productive output of people – those who have direct access to central bank money (primarily banks) will have an unfair advantage in both access to capital and information, which skews the market. The fact that they can get credit cheaper than anyone else means they will profit the most from subsequent credit bubbles.

    Thirdly, fiat currencies and fractional reserve banking are inherently unstable, which means banks need the implicit backing of the government to exist in the long run. What that does to “Moral Hazard” I think we all can take a guess at.

    A skewed market place, productivity and accountability having little impact on actual wealth distribution, unstable financial markets and moral hazard are all things that are damaging to any hope of free markets.

    Dismissing asset backed currencies, which have existed for 4000 years, while accepting fiat currencies out of hand is a bit strange (after all, fiat currencies have always been political projects created by politicians who disliked the limitations put on them by other types of money).

    Reply
  2. Nicolai Wadstrom
    Nicolai Wadstrom says:

    First fiat currencies have been few thousand years as well, used by the Romans, and were widely used by colonial powers later on and worked much like a checking system (and still do), they were not not used as political instruments as they are today. They have not all been political projects.

    And I think you are missing the point, I do not dismiss asset backed currencies, but the backing asset do not have to be gold (or similar)… Also a lot of things that were true 4 000 years ago are not true today, there world is very different place today, and trade which is the basis of our global society is very different.

    Some (like economist Michael Sproul) even claim that there is not such things as the currency is backed by the bank that issues them. All fiat currency central banks agree to exchange their currency with another currency (which is the basis for the fiat currency).

    I do agree that they are used as a political tool. My point it is that fiat currencies is not the problem, put political tampering, the market sets the price of the fiat currency.
    And the credit based currencies that can hid behind a fiat currency. The backing in gold (or equivalent) is not the actual issue here. But you put your finger on it again, the problem arises on how credit is managed.

    But the asset backed currencies were just as abused by the governments through-out history, with strict control of the trade on gold to protected the currencies. So these have been just as abused and controlled (just in another way).

    Fiat currency values are set on the global spot markets for currencies (just any other commodity is), and should the true represent the market appreciation of the currency at any given time.
    Now if they always will represent a fair value is another discussion, because there will always be a discrepancy (in knowledge or advantage), but should not be too far of, except in extreme cases (which we have seen a few), so I am not saying it’s perfect model far from it.

    This whole thing goes back to, is there a limited supply of wealth in the world? Is there one cake with a 100 pieces and that’s is? If your only actual input is natural a finite resource such as gold that would be true, and is what the left movement (socialists and communists) based there wealth distribution models on.

    But our economy is not based on what can be produced out of gold (or limited thereof), but increasingly out of services. And we are constantly making things more effective, and see a constant growth. So how do you fit that into a currency backed by Gold? It’s hardly the solution either.

    What drives the economy changed more in the past 100 years than in the past 10 000 years, so why would 4 000 old models still be as applicable?

    The real problem if you ask me is that I am not sure either model works in a global, service and technological driven economy.

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