I have a question about fiat money. It was said in the above thread that countries abandoning the gold standard had faster recoveries and more stable economies.
My question, assuming the above is true, is:
We’ve only been off the gold standard a relatively short time. Might not there be issues in the future?
Allow me to explain…I am not an economist nor consider myself well versed in it…so my thoughts might be very wrong/offbase…
In a gold standard monetary system, the above thread I linked people seemed to agree currency would tend to slowly deflate over time as wealth is created more than used up/destroyed. However, you can still get boom and busts within.
Now, it seems to me that a society with large amounts of people owing each other is more susceptible to a bust cycle (bank runs etc). The debt people owe each other and to institutions needs to get resolved which can set up an up cycle.
In a fiat money system, the government tries to mitigate these down turns by making money cheaper…which means the downturn is not as bad or even avoided. However, this means the debt is still there and growing…moving into an upcycle where more debt obtained.
Is the threat of this debt completely dissipated by inflation? Or is there a possibility that fiat money just made it appear to be more stable because we havn’t gone through a full cycle with it yet? Could the mother of all downturns be coming…in even 100 years distant?
I read the above and realize I am not wrting about this well…but hope peeps can see what I am trying to say.
{NOTE: I do not have a hidden agenda…I am not an advocate for returning to the gold standard. I just want to try to understand this concept.}
If inflation becomes too high, the faith in the value of fiat money is lost and lenders would eventually request something else as payment. As a lender, if I lost faith in the US Dollar or Mexican Peso, I’d request my repayments be made in Euro’s, or titles of real estate, or gold, etc.
You can’t “manage” debt with inflation. Lenders (and that includes not just banks but regular folks like grandmothers with savings accounts) would eventually wise up to the fact that the fiat money is losing value too fast. You can fool the masses with creeping inlation of 1% per year but not 25% inflation.
The value of the US Dollar will probably eventually be “reset” through some major combination of economic and political events. The value of the US Dollar is backed by how USA handles its finances. If it takes out too much debt to try and pay for Social Security, Medicare, Medicaid, UHC, military, etc, then other countries will notice and the value of the dollar will plunge. Eventually, new currency notes would then be issued – maybe backed by gold or California parks or everyone’s first born – whatever asset in the future that would give the new fiat money credibility.
Probably won’t happen next year though. But it has happened before; and it will happen again.
There’s no need for assumptions about documented history. Just look at the information presented in that thread.
And yet the data supports the exact opposite conclusion.
Remember that we had a gold standard during the Great Depression. Didn’t help much, did it? Despite the gold standard, there was still bad lending, bad investment, bank runs, and panic. They had a three-year-long downturn which was only reversed after FDR was elected and policy was changed. In stark contrast, the modern Fed didn’t wait 3 years to take action, but responded to our most recent crisis (the biggest since the Depression) by burning up the printing presses and doubling the monetary base. The result? Most every prediction of future economic growth indicates that the US is currently escaping from the recession (with job growth to lag behind, unfortunately).
This can potentially happen. But it’s also a huge oversimplification.
First, bust cycles have different causes. The oil shocks of the 70s weren’t caused by bubbles from mal-investment, and you just can’t use aggressive monetary policy to combat those sorts of negative supply shocks. All you can do is suck it up, and in fact, Paul Volcker is lionized as Fed chair precisely because he made us suffer. We had an extended recession due to Volcker’s policies, the worst of the post-war era not counting our current problems, but he successfully whipped the inflation that was spurred by those oil shocks.
Second, there will be always problems with bad loans and debt in the financial markets without adequate regulation of those markets. Poor monetary policy under a fiat money system can make things worse, with Greenspan’s policies being the pre-eminent modern example, but that’s only half the story. Again, we didn’t need a fiat money system for the Depression. The financial system managed to fuck itself over just fine until the FDIC came along to set things right and regulate the system.
We had our newest crisis because of the shadow banking system that developed over the past several decades, and which is now actually bigger than the conventional banking system even though it managed to avoid all those old regulations. They got away with 30-to-1 leverage because people like Greenspan thought there was no reason to regulate. Again, that was completely wrong. Big financial busts are caused by myopic bankers who aren’t being carefully watched, regardless of the monetary system.
Third and most important, economies in crisis do not work the same way as healthy economies. It was a mistake by Greenspan to keep interest rates so low for so long. His policy absolutely did help to inflate the bubble. But now we’re in this mess, which means the economy has moved too far in the opposite direction. Previously, there was too much debt. Now there is too little. The financial markets are panicky. They don’t do anything moderately, and so they end up overcompensating.
When the economy begins to recover, the Fed will start to suck those dollars back out of the system. They messed up last time, but the great thing about geeky technocrats is that they do learn from their mistakes. In the future, instead of leaving monetary policy up to the discretion of the Fed chair and advisers, we’re going to be following more objective guidelines like the Taylor rule or something similar.
Absent worldwide collapse, it can’t get worse than a worldwide economic crisis that allows people like the Nazis to take over.
No, there will not be a collapse in a 100 years because of fiat currency. The next big crisis will be based on failures to regulate the markets, or negative supply shocks, or Congressional incompetence, or something else we can’t even think of right now. And depending on the problem, it will be our fiat currency that will help us recover since we can issue more money as needed instead of having to dig it out of the ground.