Source: BullionStar – Confidence – the emotion that holds all fiat currencies together
The United States had no legal tender laws until 1862 when the US government enacted them to ensure that the public would accept the paper notes that were issued. These notes were nicknamed greenbacks – a name that is still used today to describe the US dollar. The US government had issued these notes when it needed to finance the Civil War. Hard money in the form of gold and silver had curtailed their overspending. Unfortunately, a war had to be won even if they could not afford it.The issue of paper notes allowed the government to finance the war now but pay… in the future.
At that time, legal tender laws were new as money used in the payment of goods and services had always been gold and silver. Now people of all walks of life have to accept paper notes as payment for all debts, public and private. Soldiers fighting in the war had to believe that the paper notes paid to them for risking their lives had value. Businessmen had to believe that the notes paid by the government for goods from their factories would also be accepted by other businesses. Farmers who invested productive energy and endless toil under the sun to bring their produce to the market had to believe that getting paper notes in return for their goods was a fair trade. In other words, the value of the paper notes depended on the confidence of people in it.
Nothing much has changed in today’s fiat currency system. The word ‘fiat’ means ‘it shall be’ or ‘let it be done’ in Latin. It is a declaration. In the case of fiat currencies, governments declare that the notes have value and should be accepted by the public for payment. Fiat currencies’ intrinsic value is only as much as the paper (or polymer) that they are created with. Very often, the value that is printed on the currency is higher than the intrinsic value.
The confidence to accept fiat currencies as payment depends solely on the credibility of the issuer – the government. If the issuer is reckless in printing the currency, there is lesser confidence to hold the currency since inflation erodes its value.
So what happens when there is a collapse in confidence in a currency? Hyperinflation ensues. Many people mistake hyperinflation for extremely high inflation. However, inflation and hyperinflation are very different. Inflation is the expansion of the supply of currency in the economy. Hyperinflation is the loss of confidence in a currency.
In a hyperinflation, people do not want to hold the currency for long. They want to spend it as quickly as possible. Therefore the speed, also known as money velocity, in which the currency changes hands rises. People want to quickly exchange the currency for real goods such as food and other daily necessities.
The most infamous bout of hyperinflation to date is arguably that which happened in the Weimar Republic in Germany between 1921 and 1924. Germany had incurred a huge debt when she borrowed heavily through the issuing of government bonds to fund World War I. She was confident of winning the war and had expected their enemies to pay for the cost after the war. Unfortunately, Germany was defeated in World War I and was required by the Treaty of Versailles to pay war debts either in German gold marks (Germany’s gold linked currency until 1914) and goods like coal, wood and other assets. This added to Germany’s debt burden.
It did not help that France invaded Germany’s Ruhr region in January 1923 when there was a delay in Germany’s delivery of goods which was part of the war reparations. The Ruhr region was Germany’s key industrial district – a crucial source of income and resources for the country. Without it, Germany had to obtain resources such as fuel from other countries which further depleted its foreign reserves. Germany’s economy gradually suffered due to the reduction in goods production. The reduction in revenue was compounded when the German government financed an expensive program of ‘passive resistance’ in which the workers of companies in the occupied Ruhr region went on strike in retaliation to the invasion.
Already saddled with a great debt load, Germany resorted to printing marks to pay for its obligations. The German currency rapidly devalued against other currencies.
The German government was stuck in a conundrum – if it stopped printing marks, the country would have to declare bankruptcy. If it continued printing marks, it risked stoking hyperinflation. As history would bear out, they chose the latter.
In 1922, the price of a loaf of bread which cost 160 marks skyrocketed to an incredible 200 billion marks in 1923. Workers were paid as often as 3 times a day so that they could pass their wages to family members to buy food. Unfortunately, prices of goods rose by the hour and the purchasing power of wages held while people were in the queue fell before they could buy goods. As the nominal price of goods rose into the millions and billions, carrying wads of currencies in wheelbarrows to buy goods was a common sight. Unfortunately, the great demand to get rid of currency for real goods caused shops to be emptied very quickly. Farmers were also unwilling to trade their produce for worthless marks after a while. It was a matter of time before businesses folded and unemployment soared. The economy which was stuck in a deadly spiral of money printing had collapsed. Confidence in the German mark could not be lower.
The Weimar Republic hyperinflation may seem unlikely to happen again but let us ask ourselves the following questions:
– Are governments of major economies accumulating higher levels of debt?
– Are governments of major economies printing currency excessively to service debts?
– Do we see persistent price inflation in goods and services over time?
– Is a unit of the currency we use buying less over time?
Today, competitive currency devaluation by nations is rampant in the global economy. It is time for us to remember what real money is – gold and silver. They cannot be inflated excessively in quantity by governments and therefore hold their value very well. They do not require legal tender laws for them to be accepted. In fact, they are highly regarded worldwide and bears no flag of any nation. Gold and silver have no counterparty risk – your wealth is not dependent on the confidence in any government’s ability to make good on the promise of preserving the value of any fiat currency.