Editor’s note: Following is the second in a series of articles on money.
The Random House Dictionary defines fiat money as “…paper currency made legal tender by law, but not based on or convertible into coin.” Please note: due to the greater availability of basic information, and its general economic and political affect on Canada, U.S. data is being used unless otherwise noted.
In the first article on “Money” (Morning Star, Sept. 3), we learned that real money represents, or should represent, the value of the goods and services created by real people.
If someone creates counterfeit money by just printing it, then that person is inflating the money supply by the number of currency units being created, thus lowering the value of the existing units. Similarly, when the government creates new money beyond that representing the creation of real goods and services sold by willing producers to willing buyers, then government is, in effect, counterfeiting, and thus inflating the money supply.
The method used to inflate the money supply governs the rate at which inflation becomes visible in the marketplace. For example, if the government was to drop its fiat money into large crowds of people from helicopters, then those people will likely spend most of it right away. The likely result is that with more money chasing the existing number of goods and services, the cost of those goods and services will be bid upwards, and inflation will be immediately visible. In other words, the velocity of money turnover in the economy is very high.
However, if the government, via the Federal Reserve Bank, uses the quantitative easing method of increasing the money supply, the money goes to the banks first, and in doing so, artificially lowers interest rates below what a free market would determine. The first beneficiaries of this new, fiat/counterfeit money are the banks who put much of the money into reserves, but also lend part of it to wealthy investors who bid up the value of the stock market, real estate, etc. This results in a much lower velocity of money as it seeps into the general economy, and so inflation of the cost of goods and services is much slower and more insidious. On the other hand, as inflation becomes more obvious and confidence in the currency lessens, the velocity of money increases, visible inflation increases, and possibly becomes a runaway inflation scenario.
What use is a gold standard? To begin, the quantity of gold mined over the years has roughly equalled the growth in what is called the Gross Domestic Product (GDP). The U.S. Constitution defined their dollar as a certain weight of gold or silver, and required that government reserves hold sufficient gold at a defined value to be able to redeem in one of the precious metals (PM) whenever requested. During the late ‘60s, foreign governments became aware of U.S. overspending (Vietnam War, etc.) and so began redeeming the gold, depleting the U.S. PM reserves. However, in 1971, then President Nixon took the dollar off the gold standard because the U.S. was creating more dollars than were being backed by gold.
Thus it can be seen that the value of a gold standard, honestly administered, is to deter the government from flagrantly inflating its fiat money supply at a greater rate than the real growth in its goods and services (GDP). On occasion, the growth in gold supply increased faster than GDP (California Gold rush, etc.), the average still holds true. On the other hand, the U.S. Federal Reserve Bank (FED) was created by a number of large U.S. banks in 1913, purportedly to regulate the money supply, and creation of the FED was approved by congress. Since then, the value of the U.S.$ has decreased by more than 95 per cent. All of the FED’s manipulations over time have had a serious negative effect, not only on the U.S. economy, but also on the Canadian economy.
Fred Aurag has been studying economics and the world scene from Vernon’s perspective for more than 30 years.