Fiat Money: Inconvertible paper money in support of which there is no reserve of specie. Governments issuing such money usually give it the quality of full legal tender.
Dictionary of Economics, 1961 by Sloan and Zurcher. Cover price was $1.95 of fiat money. No gold was used in the transaction.
The borrower shall be a slave to the lender.
Proverbs 22:7
The United States itself is the leader of a new, hard, materialistic civilization…. whose priests are the instalment-seller and the advertising expert.
The Economist, 1935.
What they implied, what I could not hear, was that the Republican Party, now in the grip of the Reagan forces, had abandoned the reality of the retail world in which politics had always been done: they had put emotion to work in the service of ideology. The politics of the nation had been given into the hands of the salesmen, and it was certain that the salesmen would win, for they had learned the secret of modern politics, which is that no one can refute the arguments of the heart.
From "A Nation of Salesmen: The Tyranny of the Market and the Subversion of Culture", by Earl Shorris, 1996.
Debt is said to invoke necessary discipline, simply because you have to pay it back, or risk foreclosure, or a credit downgrade which increases the cost of future debt. Private debt is said to be more disciplined than public debt because it requires you to earn income and profits to service your debt obligations, including interest payments. Public debt on the other hand usually results in governments raising taxes, or more debt, in the hope that inflation over time, or an election loss, will hide their profligate behaviour. The problem with governments, of course, is that they face the electorate on a regular basis which encourages unsustainable pre- election policy followed by the need to pay for it post-election. A lot of the cost of poor policy and poor policy execution is higher interest rates. Hence the ‘voodoo economics’ of which we speak is that Ecinya remains to be convinced that de-leveraging the private sector by leveraging the public sector is sound economic policy.
Australia has gone from a domestic budget surplus of just under 2% of GDP and zero debt to a domestic deficit of 3.6% and 19% govt debt to GDP ratio, respectively. The domestic deficit is a swing of $50 billion. Wow! Though these deficit numbers are relatively low and well short of the USA at 10% and 55% respectively, it still means that we are exposed to any downturn in the global economy and vulnerable to the unexpected, such as event risk and, say, an oil price spike. Australia has not done anything in relation to substantive industry policy (other than trade white papers that omit any reference to imports) for about two decades to mitigate our persistent trade deficit.
Rather the stimulus package (that ‘saved’ us from recession) and government policy on work-place ‘reform’ has entrenched us as a nation of chronic importers. Because of inflexible and unrealistic labour laws and high taxes on employment, Australia will produce about the same, but using less labour and thus creating more welfare recipients. An import is a job created abroad.
Ecinya Insights, "Our view of the year ahead", 12/1/2010.
Countries can reduce their private debt, reduce their public debt, or run a trade deficit, but not all three at the same time. If a country wants to see its government run a fiscal surplus (or small deficit) and at the same time its private citizens want to reduce their leverage (common desires throughout the developed world), it must run a trade surplus. That’s a simple accounting statement.
John Mauldin’s weekly blog "There’s a Slow Train Coming", 4/6/2010
Clearly the central bank of Zimbabwe has overdone it. But if the central bank of the USA has overdone it few seem aware of it. The secret is to give people more money, but not so much more that they realize all they’re getting is pieces of paper. Paper money may be a fraud, but it still represents purchasing power. When more units of it appear, people assume they have more purchasing power. And when they spend more the merchants think there is more demand and increase production. Pretty soon there is a boom.
Bill Bonner in 2007, author of "The New Empire of Debt", written in 2009 with Addison Wiggin.
Quotes above: The Core Messages (note old journalistic adage – ‘90% of the message is in the head-note’)
- Definition of fiat money.
- Even the bible speaks of debt, indicating that debt is hardly a new concept. In relation to the biblical quotation the Latin expresses it well : ipsa res loquitur: – "The matter speaks for itself"
- The Economist speaking of the new age of consumption via the provision of credit to the consumer.
- Governments take from certain sectors and give to others in the hope of buying votes, confessions of an advertising guru turned economic and social commentator.
- Ecinya talking about the dangers of public debt, January 2010.
- John Mauldin makes some very prescient, relatively obvious, points about sovereign finances.
- The ‘Empire of Debt’ is obviously The United States of America.
THE FIAT MONEY SYSTEM
We live and work in a fiat money system. We produce goods and services and we are paid in cash or a cash equivalent, such as a direct credit to our bank account, we then withdraw the money as cash or pay it to a credit card company as our bills fall due. Companies borrow from investors via various forms of debt, but mostly from the banking system who provide credit from their borrowings with a central bank, or other banks, or the savings of depositors.
Paper currency is not new. It existed in 1716 in France, fell into disuse, and then re-emerged in 1791. Paper money found its way to America in 1862 when Abraham Lincoln passed the Legal Tender Act. The Federal Reserve System was put in place in 1913. After World War ll Germany became a massive printer of money. In 1934 President Roosevelt revalued gold from its official price of $20.67 to $35 to enable the printing of more paper money with the hope of lifting America out of The Great Depression. In 1944 The Bretton Woods Agreement was made to treat the dollar as a substitute for gold. At the official price of $1 for gold pegged at $35 an ounce, countries holding gold or US dollars could print money up to that limit. In 1971 President Nixon ended the gold standard, ending convertibility of dollars into gold.
Paper money has generally preceded outbreaks of rampant inflation as a large quantum of dollars chases a limited supply of desired goods and services.
INFLATION
There are three faces of inflation. Firstly, a general rise in the cost of goods and services. Secondly a rise in asset prices. Thirdly, a rise in the current account deficit as imports exceed exports via the trade balance as countries find it cheaper to import than to produce goods and services themselves. An easy example is the outsourcing of call-centre jobs to Bangalore and Malaysia etc. Another easy example is Wal-Mart where on a store visit our editor found that only the toy department stocked ‘made in America’ goods.
However, in a money printing environment such as that pursued by Alan Greenspan and then by Hank Paulson and Ben Bernanke, having too much money chasing too many goods and services is not an inflationary problem, because we have excess money supply chasing excess capacity. And this increased supply is mainly to do with the emergence of Asia where technological abilities, skill sets and an over-abundance of cheap labour enable goods and services to be produced cheaply for export to the idle and indolent west. And this is not a political statement, it is simply economic fact.
WHAT MAKES UP THE SHORTFALL?
In the good old days classical economics taught us that consumption and investment was funded from savings. But the phenomenon of excess consumption that began in the 30’s has survived with but occasional interruption, and over the past decade or so, with increased momentum. That process is a debt funded boom People consume today out of borrowings. In a real sense savings is spending forgone. The latest manifestation of this debt phenomenon is the transfer of debt from the private sector to the public sector. The private sector has de-leveraged and the public sector has re-leveraged.
BUT GOVERNMENTS HAVE NO MONEY!
Governments get their money from three principal sources – taxation, borrowings, and running a few public utility-type businesses. An example of businesses formerly run by governments would be Commonwealth Serum Laboratories (now CSL), Commonwealth Bank, and Telstra. Government budgets are just cash-flow statements – money in and money out. Little or no distinction is made between discretionary and recurring expenditures, and capital items. There is no Profit and Loss Statement, and there is not a Balance Sheet. If governments discourage private investment then the alternative is to increase our level of imports. This reduces job creation at home, increases unemployment, increases unemployment benefits and other forms of welfare (such as ‘free’ health). Pretty soon the budget surplus turns into a budget deficit.
But governments should run budget deficits at appropriate times PROVIDED the expenditures that contribute to that deficit are well targeted. What is happening though in the Western world is that fewer and fewer producers are servicing a growing number of welfare recipients. The Henry Tax Review recommended the creation of a super-welfare agency so that welfare could be properly monitored and controlled. The Australian (and American system) with active welfare states and activist Federal welfare leads to substantial abuse and waste.
So the fear and the problem is that over time we all veer towards being Greece where the government in effect had to borrow money to employ public servants who did very little. When we then impose ‘austerity’ there are riots and lootings, anger and mayhem.
WHY THEN PRINT MONEY?
Simple. Inflation is better than deflation, depression, or even a slow-down. Keynesian economics has reached its illogical conclusions, its zenith of idiocy. Fortunately in a fiat money system it will not matter until one day we finally reach the levels of our own misunderstandings and delusions. Even wars can be financed on credit provided China, a surplus country, is prepared to lend money to a deficit country like the United States of America.
IS THE ANSWER TO GO BACK TO THE GOLD STANDARD?
The answer is no. The economic debacle of the 30’s spelled the end of the gold standard. Modern economics has finally melded with modern politics. It is highly unlikely that an ounce of gold will be legal tender at Harvey Norman, Woolworths, David J or McDonalds. Our belief is that the fiat money system has travelled and prevailed for far to long to revert to the gold standard.
CONCLUSION
We do not yet know the limits of the debt-laden system. We do know that it takes more and more debt to get to a desired level of production and consumption, or lifestyle. We do know that people are better off in jobs than having nowhere to go, nothing to do. We also know that television and communications and education has increased the desire of the under-privileged to have a better life. In broad terms when you have trouble paying the interest bill each year then your debt limits have been reached. The alternative then is to sell assets. Will the Acropolis in Athens be sold to a group of Chinese developers and shipped back to Beijing as a tourist site and the now vacant Athenian land used to build a factory or a group of condos? Probably not. The answer over time will probably be that Greece remains a distressed asset and likely to default. It would be handy if they could leave the Euro, drop their prices, and attract more and more tourists to swim and sail in their pristine waters, listen to the music and be consumed by the dance.