Chapter 2 | The nature and status of fiat money

in blockchain •  last year

Legal tender is a medium of payment recognized by a legal system to be valid for meeting a financial obligation. Being the payment of taxes a financial obligation to which all citizens are subject, the State enjoys the privilege of issuing the one currency that everyone needs, and therefore, is willing to accept. However, for a long time this privilege has been shared with banks, which are also entitled to discretionary create money. This is done by the provision of credit which, unlike it is widely believed, is created ex nihilo. Another common misconception about modern money concerns the “backup reserve”. Since the abandonment of the gold standard money has become fiat, meaning that its value is given by the faith of its users that it will preserve its value because the State will perpetuate its legal tender status. There is no stock of gold or any other asset at the central bank ensuring that the value of the national currency is kept constant at any given point of time. Hence, the value of the money that ordinary people earn in exchange for their work is subject to uncertain fluctuations that bear no relationship with their effort whatsoever. More importantly, under its current status the availability of money as means of exchange that bolsters real economic activity and employment is seriously threatened by factors that go beyond the domain of local communities and sometimes even the nation as a whole (for instance, a global financial crisis).

The fact that fiat money is issued on a monopoly basis by the banks implies that, as in it happens with monopolies in general, it can be made artificially scarce in order to make it more expensive and, as a result of this, make extraordinary profits. This artificial scarcity of fiat money means there is never enough of it where it is needed, and too much of it where it does harm to society and the environment. “It is the fundamental reason that our society is competitive instead of cooperative, and is the main reason why billions of people around the world, both in poor and affluent areas, are struggling to make ends meet” (Dunkley, 2017).

Another problem of fiat money is that it attempts to deliver the three functions that it supposedly has to: being an adequate medium of exchange, being the unit of account (i.e., the measure where all commodities express their value) and being a store of value. As John Maynard Keynes pointed out almost a hundred years ago, this way of conceiving money raises a fundamental problem. If money is a good store of value it can become contradictory with its function as medium of exchange. Since the possibility to hoard money implies that part of its stock is being leaked out from the system, an obvious result is that the number of transactions that can be realized will be reduced. This is particularly evident in times of uncertainty, where people, firms and banks tend to increase savings for precautionary reasons. In these cases liquidity (money) evaporates leaving no room for transactions. As a result, severe recessions implying massive losses of welfare take hold.

The scarcity aspect of fiat money can also be clearly seen when we consider a common problem that occurs in many small communities, especially poorer ones. The residents have almost no money. This means that even though together they have many different skills and needs, the entire community is at a stand-still because none of them have the government-issued paper that allows any exchange to occur. The natural role of money is to ensure that a group’s potential to exchange their goods and services can be realized – if people are unable to exchange them solely due to lacking the correct piece of paper, then there is clearly a requirement for them to be issuing their own paper (Dunkley, 2017). This is what complementary currencies offer.

Chapter 3 | The financialization of development: limits and problems

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With blockchain technology and cryptocurrency on the rise, it makes me doubt the overall longevity of a viable fiat currency system. Times are changing fast!
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Thank you!