The Miracle of Fiat Money
In 1971 President Richard Nixon took the United States off of the gold standard. Under the gold standard, US money was redeemable for gold, or “gold-backed”. What replaced gold-backed money is what is called “fiat money”. Fiat money is not backed-up by gold or redeemable for gold, but is simply declared to be money by the government. But, fiat money has one amazing advantage: it gives a nation the sovereign control over its monetary system and affairs, and provides the tools to promote advanced economic policies.
The Problem with Gold-backed Money
The old gold monetary system made an economy dependent on having enough gold to allow it to function correctly and to allow the economy to grow unimpeded by the monetary system. When gold was in abundant supply, the economy flourished. When it became less abundant, the economy suffered. And growth was held back without adequate gold to support the growth. These fluctuations and inadequacies in the supply of gold added instability to the economy. Fiat money does not suffer from these fluctuations nor from a limited supply. In fact, fiat money can be used to correct any fluctuation that occurs in an economy and it can be expanded to meet the needs of a growing economy. Since any money supply naturally expands and contracts due to banks increasing or decreasing loans under the fractional reserve banking system, the economy is naturally unstable–even without the instability of the gold supply. The current fractional reserve banking system of the United States is horribly unstable, even with fiat money. Going back to the gold standard would add even more instability. People who advocate a return to the gold standard say that it is more stable since there is an inability to add money to the system by printing money. They think that going back to the gold standard would cause inflation to go away and also increase the stability of the economy. A broadly held misconception is that a gold-backed money supply cannot be expanded like fiat money. But it is ever expanding and contracting. This is, due to the same fractional banking system. Changes in the level of bank loan-making caused the instability. Every time a bank makes a loan, it is expanding the money supply. If it slows-down its loan-making, the money supply contracts and the economy contracts. Since the gold money is also loaned, re-deposited, and re-loaned multiple times, the gold-backed money is also expanded multiple times. This feature of banking works the same whether the money is gold-backed or fiat. And when the banks decrease money loaning, the money supply contracts. When the money supply contracts the economy contracts and unemployment increases.
How Fiat Money Corrects the Deficiencies of Gold-backed Money
Fiat money can be used to counteract these fluctuations, stabilize the economy, and totally prevent recessions. As the economy begins to contract, fiat money can be used to purchase infrastructure and to make other investments in the nation. Making purchases with fiat money is not inflationary as long as the purchases do not cause product and services demand to exceed supply. Inflation is caused by too much money chasing too few goods. The added money merely enables the real economy expand by increasing the production of goods and services while eliminating unemployment, decreasing consumer debt, and increasing savings. Timing increased government purchases to counter the business cycle keeps the economy at full employment and full production. When banks come to understand how this will be countering economic downturns, they will not be panicking and decreasing loans, as in the past.
In the past, the economy was stymied for want of enough gold to maintain the transaction and investment demands of an expanding economy. But, with fiat money a national economy does not need any gold or other barter commodity to keep the economy expanding and the standard of living growing. Fiat money fulfills all of an economy’s currency requirements and also the requirements for demand that are necessary to prevent downward-turning business cycles.
Currently, the United States is not receiving the full benefit of having fiat money. It is still partially operating as if it were still on the gold standard. Because of this, it is illogically borrowing money when government spending exceeds tax revenue. To correct this irrationality, the injection of currency needs to be funneled through the US Treasury, as specified in the US Constitution. With this correction, the Congress is no longer constrained by the limits of revenue collection from taxes. And, the National Debt of trillions of dollars can be eliminated with no negative repercussions, including no added inflation.
Another problem with the current Federal Reserve-controlled system is that the route that the Federal Reserve uses to issue currency does little to stimulate the economy and counteract the business cycle downswings.
There is a limit to the amount of fiat money that can be spent without causing inflation. Once the economy reaches full employment and full production, the spending must be somewhat balanced with revenue generation. Pushing more money and demand into an economy that cannot deliver more goods and services would lead to inflation. The expertise and restraint of an independent Federal Reserve must to be applied to gauging the condition of the economy and timing monetary injection by the Treasury to achieve stability.