Up until 1971, real money was known as gold and silver bullion and coins. With the help of Richard Nixon’s abolishment of the gold standard (Breton –Woods agreement, 1971), today our money is known as fiat currency, which has been adopted by every country in the world. Gold as money has existed for over 5000 years; fiat currency for only roughly 40 years.
Keynesian economists and politicians embrace fiat currency as it allows them to have zero limits in the creation of money. Money printing provides them with a tool that can artificially stimulate the economy while having positive public support (and which company would not like to receive pay cheques from the government without any strings attached?). In reality, a fiat currency’s real value is left in trust with our government. Too much money printing by government will lead to high inflation. Since the price of almost everything rises during inflation, a country’s gross domestic product (GDP) will also most likely rise in connection with inflation. There is little wonder as to why governments perceive a higher GDP as economic growth and an indicator of a healthy economic system. The reality of the situation is in stark contrast to this view: a higher GDP means nothing if it is not higher than the rate of inflation. However, a typical GDP number is supposed to be inflation adjusted. These statistics are distorted (will describe in a future post) and paint a picture parallel to their agenda.
Actual physical gold needs to be mined from the earth’s crust, moulded, and fabricated into bullion and coins. This process is labour intensive and the supply of gold entering into the system is limited to the amount mined; as such, the supply of a gold-backed currency will also be limited. Having a currency that is backed by gold limits government in spending and helps in the prevention of inefficient allocations of money, since money is scarce. The easier it is to create money, the easier it is to abuse its supply; in turn, its actual value decreases.
Lax monetary stimuli have contributed to exploding debt levels around the world. A Keynesian approach to this problem is to inflate and debase currency to wipe out old, pre-existing debt and other obligations. The question is, for how long can this trend continue? This approach only postpones the inevitable and creates an even bigger bang once the problem reaches due. Let’s use another analogy to clarify this last point. A stimulus is like a drug: once you become habituated to it, you need increasingly higher doses to have the same high. In our situation, our system constantly needs debt (i.e. stimulus) to stay afloat; once the “drug” is pulled out, markets crash until another round of stimulus enters. This begs the question: does it take more drugs for an addict to quit his habit?
Like the effects of drugs on our junkie, the stimulus comes at a price. The more debt there is in a system, the more interest this system has to pay on its loans. Debt corrodes the economy’s capacity to function a free market.
Fiat currencies necessitate fiscal responsibility on a government’s part, but inherent in this type of currency is one very irresistible temptation: the temptation to print money with impunity. Like a child left alone in front of a cookie jar, governments have tended to view fiat currency and unregulated spending as synonymous. Only a currency that is backed by something concrete—something as concrete as gold—can create limits to otherwise seemingly unaccounted government spending.