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 it 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 the fractional reserve banking system, the economy is naturally unstable: even without the instability of the gold standard. All fractional reserve banking systems, such as that of the United States, are unstable. People who advocate a return to the gold standard mostly hold 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 can be expanded. And, it is ever expanding and contracting. This is, again, due to the fractional banking system. It depends on the level of bank loan-making. Every time a bank makes a loan, it is expanding the money supply. Since the same money is loaned, re-deposited, and re-loaned multiple times, the same 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. As long as there is unemployment and excess productive capacity, inflation will not occur. The added money merely enables the real economy to increase 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.
In the past, the economy was stymied for want of enough gold meet the transaction 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 power to create currency needs to be removed from the Federal Reserve and restored to the US Treasury—under the control of the US Congress—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 instantly with no negative repercussions, including no added inflation. Other work-arounds to the constraints of Federal Reserve monetary control can be utilized: such as minting large-denomination coins. This is still permitted, even with the Fed’s current role of currency generator.
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. But the beauty is that this situation can only be reached under full employment and production: a great situation to be in.