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What Are the Top 3 Things People Get Wrong About Cash?

Cryptocurrency is a complex topic with plenty of misconceptions but – when you get down to it – regular paper money (also known as fiat) is pretty darn misunderstood in its own right.

The limitations of fiat currency are painfully evident in the current state of world affairs. How are these limitations making themselves known, and why are we using a flawed money system in the first place? Fiat money has a long history. We will look into fiat’s poor historical track record, how it has represented value, and how your financial well-being is limited by operating on the fiat standard.

People fundamentally misunderstand how government-issued currency works.

Misconception #1: Fiat is Backed by Gold (Or Anything)

The cessation of the gold standard introduced governments’ power to regulate the value of money – the fiat standard. Let’s first have a look at the characteristics that make up any given money. Those characteristics are durability, portability, divisibility, uniformity, limited supply, and acceptability. On the fiat standard, the trait of limited supply is thrown out the window. In the past, money backed by the limited supply of gold constrained governments’ ability to expand their national money supplies, which limited their ability to stimulate the economy in the case of adverse events. Modern economists commonly agree that the gold standard artificially prolonged the depression of the 1930’s for this reason.

If money was backed by gold before, what is it backed by on the fiat standard? Given that fiat currency is a legal tender solely because it is declared so by a government, the stability of that government and the associated national economy then become the backing for it. This implies that any unit of a fiat currency is a government guaranteed IOU (I owe you) that they support its value. Ultimately, money is money only because it is commonly agreed upon to be so. Therefore, if a population commonly agrees to trust a government, then that government’s fiat can take hold as money.

Modern economics is premised on the idea that the volume of the monetary supply can be increased or decreased to stabilize an economy in response to the market. This practice has demonstrated its merits, but has historically never proven to be a sustainable option.

Misconception #2: Fiat Never Dies

“Paper money eventually returns to its intrinsic value – zero.” These are the words of the French philosopher and writer Voltaire who lived during the 18th century. You may be surprised to hear this insight originated so far back in history. Not only does Voltaire’s quote illustrate how antiquated the fiat standard is, it reveals that this is not the first time humanity has been in this position. According to historians, the first fiat currency was created by China in the 11th century after they ran short of copper, and was continued into the succeeding mongol empire of Kublai Khan. Marco Polo, the Venetian traveler who observed Klublai Khan’s empire, had this to say about fiat:

“All these pieces of paper are issued with as much solemnity and authority as if they were of pure gold or silver… and indeed everybody takes them readily, for wheresoever a person may go throughout the Great Kaan’s dominions he shall find these pieces of paper current, and shall be able to transact all sales and purchases of goods by means of them just as well as if they were coins of pure gold.”

— Marco Polo, The Travels of Marco Polo

The first fiat to have existed, known under Kublai Khan as “jiaochao”, eventually met its demise due to hyperinflation.

The fate of the jiaochao has turned out to be a prophecy that would plague each fiat to have existed thereafter. Have a look here for a list of more than 500 fiat currencies that have lived and died; succumbing to war, obsolescence, hyperinflation, and the like.

Misconception #3: Fiat is the Best Savings Vehicle

Monetary policy has come a long way since the time of the mongol empire, but the basic rules of government revenue generation haven’t changed much. There are two forms of government revenue; tax, and non-tax revenue. Non-tax revenue encompasses income from government corporations, central bank revenue, and yield generated from loans. As we know, managing inflation is under the purview of central banks. Modern economic theory has operated on the assumption that about 2% of inflation is healthy in an economy. This 2% mimics the average yearly growth of the global gold supply, which the global economy has generally kept up with.

The problem is, central bank-managed fiat is subject to human error, which we can see has been an inevitability throughout history. The logic of central banks is that, by printing more, the extra money in the system can stimulate the economy to keep pace with inflation. A similar logic runs from the potential gains from war. If a country prints money quickly enough, then they can acquire enough resources in a war to make up for the dilution of the value of their money.

If the money supply is inflated faster than the economy grows, then the central bank (government) is effectively choosing to borrow from the future to pay today’s debts. This isn’t sustainable because debt is only traded for more debt. The harsh reality is that this borrowing happens at the expense of those who use the fiat, the people.

In effect, this deficit spending via overinflation can be viewed as an indirect form of tax. In 1966, American economist Alan Greenspan wrote, “deficit spending is simply a scheme for the confiscation of wealth”. If the supply of fiat where you live is being overinflated; your wealth is being diminished to service the interests of the state.

Conclusion: The Road to Hell is Paved with Good Intentions

In light of the disadvantages of the fiat standard, it’s clear that monetary inflation is a form of government control. It’s a form of control that can fortify an economy, but inevitably burdens it. It ultimately proves to be antithetical to the free market, and antithetical to the freedom of the individual. Fiat creates long-term consequences borne of good intentions due to the fiat standard’s vulnerability to human error.

Make no mistake, the top three things people get wrong about fiat illustrates that trusting an institution to regulate money is not a sustainable option.

What Else Do People Get Wrong About Crypto?

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Gerrit van Sittert

About the Author

Gerrit van Sittert

Gerrit van Sittert is a cryptocurrency investor keenly interested in the ramifications of blockchain technology. Since graduating from a commerce and entrepreneurship degree, he has specialized his knowledge of how cryptocurrencies are set to impact the global supply chain and emerging markets. He started his crypto journey in 2017 while hosting an entrepreneurial focussed meetup group in Victoria, BC.

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