Currency, it’s the lifeblood of the economy, and it’s the primary tool of control for the U.S. Government. Currency is something you’re likely often going to hear libertarians discussing, and for good reason. Ron Paul, arguably the most well-known libertarian of all time, was a staunch supporter of the gold standard, and he often spoke of his opinions on the US Dollar.

“If you want to restrain government, you restrain the power to create money. And that’s what gold does. A lot of people think, “Well, that means you’re going to have to carry all that gold around in your pocket.” No. There’s nothing wrong with gold certificates. And it can be electronic gold. It’s just that it restrains the power of individuals, especially secret individuals that have no oversight from Congress to create this money. You would certainly not need a Federal Reserve if you have a gold standard.” – Ron Paul

I know many are familiar with Paul’s sentiment toward the federal reserve (end it) but not as many are familiar with why. In this installment of Think Economics, we’re going to dive into currency.

 

The Modern US Dollar – Fiat Currency

Currency

The US dollar is what is called a fiat currency, that means that the US Government has declared it to be legal tender, however, it is not actually backed by any commodity. Most modern forms of paper money are fiat and thus are not backed by anything other than consumer confidence. The need for a fiat currency came about as an attempt to smooth out the natural booms and busts of the business cycle.

With a fiat currency, it’s infinitely easier for a central agency that controls the money to have absolute rule over the economic process. With its control and manipulative power that is practiced with interest rates paired with a fiat currency, the central bank can manage and direct the U.S. economy like a puppeteer maneuvering a marionette through a paper village.

The main characteristic of what makes a currency fiat is the fact that it is not backed by any kind of standard. This is dangerous in that the single pillar holding up the value of fiat currency is consumer confidence. It really is insane when you consider it, and it puts the importance of the stock market trends in a much clearer perspective. The better the market does, the higher the confidence of those who are playing a part in it, hence the more likely those players are to continue to invest and participate in the stock market.

There is an interesting article by NPR on the invention of money (I know it’s not everyone’s favorite publication, but that doesn’t mean there’s nothing to learn from what they’ve published) that outlines a story that has always stuck with me. There was a civilization of people whose currency was essentially giant rocks, what led to the currency being giant rocks, and how the consumers in that market held confidence in those rocks is unclear. The story breaks down a situation where an individual was looking to purchase something from someone overseas, so the giant rock was sent out on a boat. During its trip, the big rock currency fell off the boat, and onto the ocean floor. Just how powerful is consumer confidence? After having fallen to the ocean floor, once the location of the rock was confirmed, it was used as currency for years later. Individuals could claim that the currency existed on the ocean floor (scarcity and real resource as a currency backing) so there was no doubt in anyone’s mind that the rock still held value (consumer confidence), even as it sat at the bottom of the ocean.

This is interesting when you consider this was an ancient civilization, and they had already adopted essentially the same kind of approach toward transferring funds that we have in a digital age, with most of our money passing through glowing screens as calculations or reflections of money that may as well be sitting on the bottom of the ocean, for all we know.

 

Understanding The Gold Standard

Gold Standard Currency

1. Sustained higher economic growth
Over the 179 years the United States dollar was backed by gold, the average annual economic growth was 3.9% – 4%. In the 40 years since we have moved away from a gold backed currency, the annual economic growth average is 2.8%

2. It’s less risky for all the right reasons
If the gold standard were in place, the Federal Reserve could not manipulate interest rates in the way they do now to control the value of the dollar. Boy, wouldn’t that be nice? This would greatly reduce the risk of recession and the boom/bust cycle.

3. Scarcity
Scarcity leads to a lot of self-regulation by nature. It discourages government budget deficits or debt, as it cannot exceed the available supply of gold. The government can only print as much money as it has gold, so that also discourages inflation.

We’ll stop there as I feel those are the big ones. But let’s make sure we’re seeing both sides of the field with this. There are some disadvantages to using the gold standard.

The economic health of an economy would rest entirely on the supply of gold. Any country without gold is at an immediate, significant disadvantage. It creates a bit of an inherent obsession, and international governments taking actions to protect their gold can lead to dramatic fluctuations in the economy.

 

Printing currency, kinda

When you’ve got a currency that is not backed by any standard, there is absolutely no scarcity involved. This opens it up for the central authority to create funds arbitrarily to control and manipulate the economy. However, injecting new money into the economy is often called “printing more money,” when printing new money is one of the least common ways new money is injected into the economy. In this modern age, there are multiple ways that currency is created and distributed, the most common of those being the federal reserve simply imagining totals of revenue, and then making them appear inside of bank accounts. This happens during the overnight lending process that we went over in our first article outlining interest rates. The U.S. Treasury Department is responsible for actual printing and minting, and manages the U.S Mint and BEP (Bureau of Engraving and Printing). The government does, in fact, print Treasury Bonds, however, those are securities and not money.

 

Who decides when to print our currency?

Fed Reserve Currency

As mentioned before, the federal reserve lends money to banks to cover reserve levels during overnight lending periods. Short of any kind of economic disaster, this is normally the way that creation of currency happens. The Fed has 12 regional banks that oversee local surrounding areas. A bank will need money to meet minimum reserve standards, so they will request that money from the Federal Reserve, the Fed then deposits that money into the account of the said bank, and attaches the appropriate interest rate. And just like that, the Fed created money. Another thing the Fed can create is debt, and lots of it. The United States has a current national debt of 20 trillion, this is unsustainable, a financial time-bomb ready to blow at any moment.

So, what’s next? What’s the answer?

A fiat currency is backed only by consumer confidence, and is managed and manipulated the federal reserve as it attempts to control the economy. The gold standard provides many benefits that help promote fiscal responsivity, and limits opportunities for federal intervention. However, the gold standard also has its potential issues, as we’ve discussed. The issue here is the mono-currency focus. The idea that there must be only one currency, and it must be controlled by the federal government is what is keeping growth and innovation away from currency being so prevalent.

Alternate Currency: Enter Bitcoin, and Cryptocurrencies

Crypto Currency

Bitcoin, Litecoin, Bytecoin, Etherium, are among some of the emerging cryptocurrencies that exist among the block-chain. These are digital only currencies that, thanks to the block-chain technology, are free from government manipulation and control. We won’t get too into the ins and outs of Bitcoin and other cryptocurrencies, as it’s a big topic (you can learn more here if you’d like.) All of this currency is tracked in the block-chain and stored in digital wallets that are highly encrypted. The block-chain is peer to peer and keeps a record of where every bitcoin has gone. This technology eliminates the opportunities for counterfeit currency, and it removes the need for a bank or any third party organization to store and transfer the currency. That removal of the third party entity removes the mechanisms that the federal reserve utilizes to disperse money into the market and manipulate interest rates to stimulate the economy. The block-chain is also incredibly difficult to hack, as it’s a distributed system, versus a centralized system.

A lot of people ask, are Cryptocurrencies technically fiat? Yes, they technically are, but it’s not so black and white. Cryptocurrencies work differently, and as they are not backed by a reserve resource standard, they do have to be mined or otherwise legidimately produced, so scarcity exists, and with the block-chain providing the entire history of every bit passed through it, many of the pitfalls of fiat, are not the pitfalls of cryptocurrecy.

As a result, the value of cryptocurrencies continues to rise. As the value of these currencies rise and gain popularity, more cryptocurrencies are coming into the situation. This the future of currency that we should embrace, a free market solution to currency. Only by removing the mono-currency, federally controlled dependency will we be free of the negative effects that come with that kind of mono-focus approach.

The answer is not a federally controlled fiat currency, nor is it the gold standard by itself. The answer is a market with multiple options and countless opportunities.

In a market where many businesses could compete in the economy, there would be an active and innovative drive to produce and retain valuable, useful currency that would benefit the consumer, and thus benefit the economy as a whole.

“I am more convinced than ever that if we ever again are going to have a decent money, it will not come from government: it will be issued by private enterprise, because providing the public with good money which it can trust and use can not only be an extremely profitable business; it imposes on the issuer a discipline to which the government has never been and cannot be subject. It is a business which competing enterprise can maintain only if it gives the public as good a money as anybody else.” – F.A. Hayek