Fiat Currency — Why it is making you poor.

Supply vs Demand

In simple terms, a Fiat Currency is a currency that is not backed by anything except the trust that it can be exchanged for goods and services. But, because it isn’t backed by anything, governments and central banks can print it out of thin air. Yep, they can print as much of it as they want, whenever they want, and in case you missed it, that is exactly what they have been doing.

Money Supply

To illustrate the increase in money supply, let us look at the US M1 money supply. What is M1 money supply I hear you ask? M1 is a measure of the base currency supply (they call it money, but I will show that it is not, for now these terms will be used interchangeably just note that they are not the same). M1 accounts for physical currency (the actual notes and coins in circulation), demand deposits and checkable deposits (NB: savings accounts work differently in the US than what we are used to in Australia, M1 does not include savings deposits). M1 is illustrative of the base layer of money. Here is a chart of M1 money supply (Figure 1)

Figure 1. US M1 money supply 1975–2021 — source: https://fred.stlouisfed.org/series/M1
Figure 2. M2 Money Supply — source: https://fred.stlouisfed.org/series/M2

So how the hell did we get here? Money and Currency

We need to back track and understand the difference between money and currency. I have touched on this in previous articles which you can read here. We won’t rehash old ground here but the main difference between a money and a currency is the property of money being a “store-of-value”.

Figure 3. Gold Price 1970’s — 2021
Figure 4. USD Purchasing Power 1910–2020

What is the problem with Gold?

Gold is cumbersome to use as a medium of exchange. And while it is true that you can store a large amount of value in a relatively small package of gold, it isn’t very practical. We can’t very well walk off to the shop with a 1oz nugget to buy a loaf of bread. We can’t grind off some gold dust from the side, measure it and feel confident that both parties are satisfied in the transaction. So we invented coinage. We would mint coins in lower denominations, they were more portable and interchangeable. When Gold’s value meant that smaller denominations of value became impractical to exchange Other coins were introduced for smaller denominations of value. We started mixing in other metals to dilute the amount of gold, or we introduced other monetary metals like silver and copper, in their own forms of coinage.

Debasement — a history

Gold and gold coinage served us pretty well as money, but not without examples throughout history of our old friend debasement. You see, governments, royalty and politicians simply can’t help themselves. The Roman empire is a good example of governments messing with peoples money. When they starting messing with the money, this fairly well served as a catalyst for the fall of the Roman Empire. Caesar decided to start clipping coins. They would take a clip out of the sides of the coins (figure 5) and melt down these snippets into freshly minted coins while expecting people to maintain belief that their purchasing power hadn’t diminished. Then they started diluting the mix of metals in the coinage further and again expected the citizens not to notice/care(figure 6).

Figure 5. Examples of clipped coins Source https://www.visualcapitalist.com/currency-and-the-collapse-of-the-roman-empire/
Figure 6: Monetary Debasement via way of dilution. Source: https://www.visualcapitalist.com/currency-and-the-collapse-of-the-roman-empire/

Banking

Let’s shift gears a little and look at banking. Deposit banking as we know it today started as warehousing. Warehouses would once be the secure storage facilities for money, grains and commodities. If you had a large amount of gold, it was common to store (deposit) this gold at one of these warehouses where they would issue you a deposit receipt.

Currency Standards

As deplorable as the actions of the first bankers seemed by receipting more than they had in reserves, believe it or not, this is still a far better system than we have today. At least they still had SOME GOLD in their vaults. We are getting into the meat of understanding how fiat currency came about. Looking at this first fractional reserve standard, they had hard money in their reserves, that was the gold. Throughout the years fractional reserve banking became the norm and over time we developed what have been deemed as “acceptable” reserve standards in terms of how much in reserves we should have for every receipt we issue. But first, let’s look at the various currency standards we saw throughout history.

So how exactly does Fiat Currency affect the Rich and the Lower/Middle Class?

The main problems with a Fiat monetary system have already been highlighted within this article. But the most obvious problem with Fiat is the monetary debasement that occurs whenever there is trouble. Currency printing hollows out the middle class through inflation, through the reduction of purchasing power. Currency debasement ensures that our savings get eroded. It is a guarantee. Again, for a recap on how currency printing causes inflation and the affects of inflation on the middle class, please see this article here.

Today’s Fractional Reserve Banking

Now back to fractional reserve banking. The Fractional Reserve banking system is largely to blame for the enormous credit bubble we find ourselves in today. I have covered how fractional reserve banking came to be when the banks would lend out more gold then they had in reserves. Well, governments took note of the increase in economic activity that occurred by having more currency in circulation. Ones person’s spending is another person’s income after all. So not only did they turn a blind eye to it, they encouraged it.

Figure 7. What $100 deposit turns into at across reserve ratio’s. Source: https://courses.lumenlearning.com/boundless-economics/chapter/creating-money/

Who is pulling the strings?

So who makes the decisions on if/when/how much currency they print? I have already said “The Fed”. But who are they? The Federal Reserve was formed by the Federal Reserve Act of 1913. The federal reserve was formed by some of the most rich and powerful men in the world. If you google “who owns the fed, you can find some pretty interesting articles about the Fed being a private institution. I have no way of knowing if that is true, and I would rather stick to the facts and historic records. It is one of those “things that make you go hmmmm”.What is known though is that the FED is independent of government. The members of the Fed are non-elected officials. They orchestrate policies that are supposed to help in times of economic stress. However it cannot be argued that their policies result in market interventions (goodbye free and open markets, goodbye price discovery) that result in the Cantillon effect and result in policies that make the poor poorer and hollow out the middle class.

Figure 6: Meyer Amschel Rothschild

Bringing it home

This article was a lot longer than I would have liked and it isn’t quite finished yet. I believed the subject warranted a decent attempt at explaining the system and even at that, I fear that I have failed to explain it effectively.

Why is Bitcoin Better than Fiat?

Like we discussed with Gold. Bitcoin is scarce. Not only is it scarce, it is finitely scarce. Meaning that we know exactly how many Bitcoin there will ever be…. 21,000,000BTC. And we can also see exactly how many are in circulation at this point in time (18,738,568.75 at the exact time of writing 20:33pm AEST 19/06/2021). With Bitcoin, there is a scheduled and continuous reduction in the inflation rate (making it a deflationary currency over time). Knowing this set schedule we can calculate that the last bitcoin will not be mined until (approximately) the year 2140. So unlike Gold and any other asset that has ever existed, we know exactly how many are in circulation at any point in time. This is a powerful feature of bitcoin.

“But Bitcoin is Nothing!!”

One of the biggest arguments I hear from people is that Bitcoin is nothing. It isn’t physical, you can’t hold it in your hand so therefore it isn’t valuable. I can understand how people come to this conclusion. It lives on a computer system (actually many thousands of computer systems), and it exists in the form of 1’s and 0’s. You can’t melt it and wear it around your neck. Almost all of the people who present this argument however, have no idea how their fiat currency system works. They don’t know that their fiat currency exists in a small percentage of physical form and that the rest of the system exists in 1’s and 0’s also. When I present how the currency system works, the minimal reserves, the credit (imaginary currency made up by banks) and the fact that if all of us were to go to the ATM’s and take out all of our money from all of our accounts, less than 10% of us would be able to do so before total banking system collapse…..usually, once this is highlighted as a comparison, the penny finally drops.

Bitcoin is Legal Tender — Banking the Unbanked

As an example of how bitcoin is competing against the fiat system…. El Salvador, in June 2021, announced that it was adopting bitcoin as legal tender. El Salvador does not have their own currency. They rely on the US dollar for commerce, reserves and income. Salvadorians are subject to monetary debasement by US printing (like everyone who holds USD), but unlike the citizens of the US they get no stimulus checks. It is estimated that 30% of El Salvador GDP comes from remittances. Salvadorians immigrate to the US (and abroad) in order to earn USD and they send these USD’s back to their families in remittances. Western Union owns the monopoly for the transfer rails of these remittances and will charge $20–30 for a $100 transaction. That is a 20–30% tax just for the “privilege” of sending your loved ones some currency. Some Salvadorians must travel for hours via bus to reach their nearest Western Union only to be met by gangs that hang out demanding their cut of the loot before the traveler is allowed to leave.

Bitcoin is the ultimate bearer instrument. Carry your entire net wealth with you everywhere.

Countries that have experienced currency issues will often clamp down on capital flight. They stop their citizens from crossing borders with their wealth. You can’t very well get away with boarding a plane with a few thousand dollars of gold strapped to your body. However, with bitcoin, all you need is your memory to move your entire wealth. Remembering a sequence of 24 words in your memory allows you to cross borders with your entire net wealth, it could be billions of dollars potentially. And all you need on the other side is access to a computer or a mobile phone. There are obviously better ways to manage and store bitcoin than relying on your memory, (please don’t freak out with this example) I would have lost my bitcoin 50times over already if that were the only way. This is simply illustrative of the power of what bitcoin can do and why it is getting mass adoption in countries such as these.

Bitcoin is better at being Gold then Gold is.

Gold’s inability to be moved easily in large quantities is one of the reasons why the gold standard failed in the first place. As the world became more globalised, imports/exports grew between nations. Settlement in gold became expensive, slow and cumbersome. And if you had no need for the debtor nations currency, you would settle in gold. If say France needed to settle a import deficit with Japan, they would need to pile, count, weigh, package, ship and protect their gold to the destination. Depending on the level of trust Japan has with France, they need to count it, weigh it, sample it or melt it down to verify that it is pure. All this is extremely expensive and can take anywhere from 6–12mths to complete. Treasuries do not typically like moving gold, believe it or not, handling gold can actually wear it and over time decrease the weight (albeit extremely small increments at a time). With bitcoin, cross country settlement can be done within minutes for any value amount, with verifiability completed after a few blocks (typically 6blocks is considered a confirmed verification period which is~60mins, although you can see the transaction after 10mins). This can be transacted for a only a few $$$ (depending on network traffic on the bitcoin base layer). For example, France can send Japan $10,000,000,000 of bitcoin for a transaction fee of $6.46USD (using today's price on 22 June 2021 source: https://ycharts.com/indicators/bitcoin_average_transaction_fee) and this transaction would be confirmed and irreversible within an hour.

Conclusion

Bitcoin is fast becoming the perfect store of value and its utility, use and adoption is rapidly increasing. Hedge funds, pension funds, sovereign wealth funds and even nations are starting to adopt bitcoin as a % of their investment framework. We have an opportunity to front run the big money by adopting our own bitcoin standards for our households. Use bitcoin like a savings account. You can start with as little as 5c, it doesn’t matter, just start saving.

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If you are in Australia, consider using the following code to sign up for Coinspot Crypto Exchange. Disclaimer: I do receive affiliate benefits from Coinspot by using this link, however I would never recommend a product that I didn’t rate highly or that I didn’t use myself.

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