Analysis and History of Fiat Monetary Systems
April 18, 2008
I'm sure there are many of you who have an interest in the Fed and the whole monetary system (like me), yet also don't understand how a fiat money system works or how the Fed completely operates (also like me). However, as investors this is an extremely important thing to understand and now take for granted. The Fed essentially sways the economy in one direction or the other through high and low interest rates, the printing of money, and probably much more than many people know or would guess. So, how does the fiat monetary system work and what's its history? This analysis has some answers.
The fundamental flaw in a fiat money system can be summed up as human nature. When the going gets rough, the rough start printing.
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The Federal Reserve is not a part of the US Government, which seems to be little known. It is owned by a collection of the world's biggest banks.
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910 AD -
China experiments with paper money - It takes several hundred years but the system is abandoned due to unacceptable levels of inflation as money printing exceeded production.
1500'S -
Spain gathered gold from Mexico and the new world, becoming the richest nation in the world. Instead of developing their own economy they sent gold to trade partners in a consumption orgy not dissimilar to the US today. Then they went on a military rampage to extinguish pirates, (terrorists?) in an imperialistic march into other lands, dropping any distinction between terrorists, (I mean pirates) and the countries that harbor them. Their excessive consumption ran through their gold hoard, so they turned to financing the war with debt, bankrupting them.
1716 -
John Law convinced France to use paper money and declared all taxes must be paid with it to gain acceptance. The idea snowballed and paper money became more desired than coin. It led to excessive printing, additional moneymaking schemes and fraud. Exaggerated values coinciding with money printing eventually blew up the system.
1791 -
The French Government again tries its hand with a paper currency. The Government confiscated land from aristocrats and issued "assignats" which paid interest against the properties. Land was auctioned off in exchange for these notes, inflation rose to 13,000% by 1795. Napoleon ended the revolution and replaced the "assignats" with the gold franc, which set off over a century of prosperity for France. In the 1930's Socialists came to power and brought the Bank of France fully into the Government. They quickly removed gold backing of the currency and made the franc a managed fiat currency. In only 12 years the currency lost 99% of its value.
1853 -
Argentina went on a gold standard and thrived for close to 100 years. A central bank was created in 1932, beginning a long downfall. Juan Peron took charge in a 1943 coup and depleted reserves causing trade to fall. Argentina continued on this path of paper money, falling from the eighth largest economy to a mere shadow of its former self, which it has not recovered from as of today.
1862 -
Abraham Lincoln passed the Legal Tender Act allowing the Government to issue paper money, backed by nothing but government promises. A huge inflation transpired that caused the practice to fall out of favor until the Federal Reserve System was put in place in 1913.
1923 -
Weimar Republic - After World War I, Germany, crippled from its loss in the war, was held accountable for its war reparations. The country was destitute so found no other choice but to simply print the money in massive quantities to pay the reparations. The result was the plundering of the entire middle class, wiping out all value of savings, and paving the way for Hitler in front of an angry public.
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Look how long a fiat currency can thrive. Between 1948-1969 world money reserves increased only 55%, since that time they have shot up more than 2000%. See any connection? Also note that after Nixon's move, gold went up over 25 times in less than ten years. Was it discounting the unprecedented money printing that was about to unfold? A brief perusal of history will show that when a nation went on a gold standard it was the beginning of a very long period of that nation thriving. When a country went to a fiat currency there was a period, as long or longer than 30 years, in which it thrived even more. However, during that period of prosperity on a fiat currency, excesses began to build.
A very interesting read indeed. It looks more into the long-term impacts a fiat monetary system can have on a nation and economy. Certainly we are starting to see the downsides of artificially low interest rates. Sure, low interest rates boosted the housing market to record levels and people were doing great, but now the housing market has obviously hit its peak and some fear a recession in the general economy (personally I think we will avoid one in 2008, although that certainly doesn't mean it won't be a tough time for many people). What's even more ridiculous is that the Fed sees lower interest rates as the medicine to heal the economy just as it did several years ago. Going through this cycle is dangerous and will only scare people away from stocks once they realize how volatile the Fed has made the stock market. I think one of the greatest things people don't understand is that the Fed's actions are what the stock market waits for or speculates on. However, as investors who invest in stocks, we must stay focused on the long-term. It will be awhile before things with the Fed change, and we can't let the short-term movements and speculation thwart our thinking of finding a quality business for the long-term. That would probably be the biggest mistake an investor can make.
Tags:
alan greenspan, ben bernanke, federal reserve, fiat money, gold, monetary policy
Posted at: 09:55 AM | Add Comment
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