When $1 could buy you a pair of patent leather shoes: Is it true that all fiat currencies eventually become worthless?
In today’s Furious Friday episode, we’ll be running through the historical life cycle of fiat currencies.
This episode is thanks to John – John wrote in with a few great questions;
- Is it true that all fiat currencies eventually become worthless?
- Should we be concerned about printing more and more money – is this something to be concerned about, i.e. the longevity of the AUD?
We will run through:
- How do fiat currencies fail and what causes it?
- Is safe-guarding against it something we need to worry about? How would one do this?
History of money
- Barter economy – was hard for getting values and trading efficiently – hard to travel with a mule to trade their corn
- Coins – Back by silver or gold
- Promissory notes – goldsmiths used to house gold for people – those people then give the ownership to others in paper (an “IOU”) – early day banks
- Skip forward to today – All paper but mostly Fiat or digital currency
Doesn’t have to be fiat to fail – it just has to be controlled by the government
A quote from one of the US Founding Fathers – Government is like fire, when it is well controlled it can help a country to grow and support it, when it gets out of control – it will destroy everything in its path.
This is why it is important to remove government from Central banks.
- America fought the war to get away from the Bank of England – controlling their currency
- Ended up back with one a few hundred years later
Beauty of the Gold Standard was in the early days it was hard to manipulate. But even physical currency can be manipulated – as the ruler has control of the currency.
- Let’s go back to Roman times and the Devaluation of the Denarii – Coins were made of silver
- Introduced 211BC and ended around 400AD (almost 600 years)
- So, until Augustus the coin was relatively valuable, but in 100 years its value decreased significantly, roughly 2,000% devaluation altogether, when there was almost no silver left in the coins.
- Like coinage of today, Ancient Rome’s coins represented portions of larger denominations. The As (plural assēs), the basic unit – think of it as a 1c coin.
- Loss of purchasing power – During the time of the Roman Republic, you could buy a loaf of bread for ½ As or a litre of wine for one As.
- A year’s pay for a commander in the Roman army around 133 B.C. was 10-2/3 assēs, by Augustus’ rule (27 B.C.-A.D. 14) 74 Denarii, and by the reign of Septimus Severus (A.D. 193-211), it rose to 1,500 Denarii.
- Stopped using denarii and started paying in gold – Military and officials only
- Average Roman Joe was forced into Denarii
- Two-tiered economy.
Today – Rather than decreasing the quality of the coins we increase the supply of it, which has the same effect
- Look at global GDP to Debt
- Japan has the highest – over 250%!
- America is over 100%
- Australia is about 42%
According to the last federal update, we (Australia) have decreased our debt, which is great.
Liberals are trying to get back to a lower debt environment.
- Say you have parents (most people do) – Mum and Dad. Dad is a stickler and won’t buy you toys as you don’t have the money, but Mum racks up a credit card bill, gets in debt to buy toys.
- You have the toys now, but then your pocket money is halved – from $10 to $5 because Mum and Dad still have to pay back the debt.
- Government spends it, but you have to pay it back. Government debt is your debt – they can’t pay it back without you paying it off through taxes.
- Pay in more than one way – The money you have isn’t worth as much anymore thanks to inflation – the loss of buying power due to increased money supply. You don’t have the ability to increase your money supply as easily though.
The government however, can keep increasing the money supply – Let’s look at US history…
- 1900s – National Monetary Commission is established to propose legislation to regulate banking.
- US. Money Supply:$7 billion – What $1 Could Buy: A pair of patent leather shoes.
- 1910s – The Federal Reserve Act is signed in 1913.
- US. Money Supply:$13 billion – What $1 Could Buy: A woman’s house dress.
- 1920s – The Fed starts using open market operations as a tool for monetary policy (what we use today)
- US. Money Supply:$35 billion – What $1 Could Buy: Five pounds of sugar.
- 1930s – To deal with deflation during the Great Depression – suspends the gold standard. Executive Order 6102, which criminalizes the possession of gold.
- US. Money Supply:$46 billion – What $1 Could Buy: 16 cans of Campbell’s Soup
- 1940s – The massive deficits of World War II are almost financed entirely by the creation of new money by the Federal Reserve. Interest rates are pegged low at the request of the Treasury.
- US. Money Supply:$55 billion- What $1 Could Buy: 20 bottles of Coca-Cola
- 1950s – The Korean War starts in 1950, and inflation is at an annualized rate of 21% due to low rates – so they increased the rates
- US. Money Supply:$151 billion – What $1 Could Buy: One Mr. Potato Head toy
- 1960s – U.S. dollars in circulation around the world exceeded U.S. gold reserves.
- US. Money Supply:$211 billion – What $1 Could Buy: Two movie tickets.
- 1970s – In 1971, President Richard Nixon ends direct convertibility of the United States dollar to gold.
- The federal deficit doubles, stagflation hits, and the oil price skyrockets – all during the Vietnam War.
- Over the decade, the dollar loses 1/3 of its value. – US. Money Supply:$401 billion
- 1980s – Stock market crash – The Federal Reserve stepped in, “The Federal Reserve, consistent with its responsibilities as the nation’s central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system”. This just means they printed more money!
- The Dow would recover by 1989, which prolonged the recession which was occurring. The US. Money Supply:$1,560 billion. What $1 Could Buy: One bottle of Heinz Ketchup.
- 1990s – This decade is generally considered to be a time of declining inflation and the longest peacetime economic expansion in U.S. history.
- US. Money Supply:$3,277 billion – What $1 Could Buy: One gallon of milk.
- 2000s – After the Dotcom crash, the Fed drops interest rates to near all-time lows.
- In 2008, the Financial Crisis hits and the Fed begins “quantitative easing” (aka printing more money!)
- US. Money Supply:$4,917 billion – What $1 Could Buy: One Wendy’s hamburger.
- 2010 – After QE1, the Fed holds $2.1 trillion of bank debt, mortgage-backed securities, and Treasury notes. Shortly after, QE2 starts.
- Purchases were halted in October 2014 after accumulating $4.5 trillion in assets.
- It wasn’t for the bank bailouts – or for ‘economic stimulus when it is funded through bad debts’
- US. Money Supply:$13,291 trillion – What $1 Could Buy: One song from iTunes.
Money supply was just $7 billion 100 years ago. Today there are literally 1,900 x more dollars in existence.
The buying power of a dollar has changed significantly over the last century, but it’s important to recognize that it could change even faster (up or down) under the right economic circumstances.
What causes them to fail?
- Giving the Government all the control – Venezuela inflation at 1m%
- Too much supply – the process of printing money to bail out debt
- Debt is future-Government’s problem, printing money and giving people what they want is a way to stay popular.
- Not enough demand – Someone needs to want your currency now for it to retain its value
- When we were exporting a lot – 1AUD was 1USD – people wanted Aus Cash for Aus goods and wanted to invest here
How to avoid this (though there’s no simple answer)
- We live in a democracy and we should be voting against government spending, even if it’s hardest way
- Just remember when voting for government spending – large amounts are funded from debt
- Own assets that increase in value or that are unrelated to inflation
- Unrelated to inflation
- Crypto currency
- Gold, moves like a volatile asset as well, but the supply doesn’t go up by much
- Physical assets
- Buying shares, property, anything that has a long-term growth component to it
- After inflation the real return on cash is pretty much negative
Thanks for listening, as always! If you have any questions contact us at https://financeandfury.com.au/contact/