Business Case studies

21st August 2019

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Zubair Bukhari

21st August 2019

Paper money eventually returns to its intrinsic value – zero

At one point in time, money was backed by the tangible value of gold or other precious metals, legal tender for anything of equal value.

That is not the case any longer. The value of a dollar bill today is what the government says it is. This arbitrary value is dependent on the actions of the government. There are no limits to how much money a government can put into circulation.
That is because this money isn’t backed by any real value; it is ‘fiat’ currency.

What is Fiat Money?

Fiat money is a government-issued currency that is not backed by anything physical. The value of fiat money is based on supply and demand and the stability of the issuing government, rather than the worth of a commodity or other asset backing it.
While fiat money gives governments’ central banks greater control over the economy because they control how much currency is printed, one danger of this is that governments will print too much of it, resulting in hyperinflation.

The problem with Fiat Currency.

Throughout time, attempts of using fiat currency, even today, have failed. When governments print money that isn’t backed by any value, disaster inevitably ensues. Paper currency has led to the collapse of many economies that have tried to institute a fiat currency to trade for goods and services, yet the long history of failed fiat currency is being ignored by today’s central banks and governments.

Because fiat money is not linked to physical reserves, it risks losing value due to inflation or even becoming worthless in the event of hyperinflation. When people lose faith in a nation’s currency, the money will no longer be of any value. That differs from currency backed by gold, for example; it has intrinsic value because of the demand for gold.

Since fiat money is not a scarce or fixed resource like gold, central banks have much greater control over its supply, which gives them the power to manage economic variables such as credit supply, liquidity and interest rates.
When governments began printing paper money these notes were considered to be as good as gold.

In theory, everyone who held this paper currency could go to a bank or financial institution and convert their currency into physical gold. This is what became known as the gold standard. Initially, the governments only printed as much currency as they had physical gold to back it up.

But soon they realised realized that the physical commodity backing the currency was tying them down from unbridled spending and also that a situation where everyone went to exchange their currency for gold would likely never happen. So, they began to print more paper money, thus creating the fractional banking system.

The manipulation of fiat money quickly resulted in the manipulation of fiat debt, benefitting a select few and ruining the rest.

Dollar vs Gold
The US dollar became fiat currency when it stopped being backed by gold over 46 years ago and it has lost 97 per cent of its value since the establishment of the Federal Reserve in 1913.

Examples of failed fiat currencies

China was the first country to use paper money in the 7th century.

This worked briefly since the paper could be traded for rare, valuable metals, such as gold and silver but as China entered into a costly war with Mongolia and in an effort at expansion started to flood paper money throughout the empire. As China’s trade grew, the influx of fiat paper – currency backed by no value – caused even the wealthiest to be ruined.

France has tried to implement, and been defeated, by fiat money three times.

King, Louis XIV, left his successor heavily in debt, who took the advice of the Scottish economist John Law and simply flooded the country with paper currency instead of the previously acceptable coins.

The paper money devalued the actually valuable coins, causing the heir to bankrupt his own country. Yet France didn’t learn its lesson the first time, more than 100 years later, France gave paper money another attempt, creating an inflationary spiral of 13,000 per cent. Napoleon, and the introduction of a gold-backed Franc, eventually settled the crisis.

Another country faced with unpayable debt was post-WWI Germany.

Germany did not learn from history. Instead, it created a state of unheard-of hyperinflation. A huge number of printing companies began printing out paper money as fast as they could, devaluing the German Mark so much that its only real value was to be used as kindling.

It seemed American might finally have learned a lesson. Up until 1913, American currency was strictly backed with actual gold.

The establishment of the Federal Reserve that year reduced the amount of gold officially backing the dollar and owning gold became illegal. In 1971, the gold standard was eliminated as the US dollar officially became another piece of paper. Its value has decreased by 92% since 1913.

Growing discontent in Venezuela, fuelled by hyperinflation has led to a political crisis.

The biggest problem facing modern-day Venezuelans in their day-to-day lives is hyperinflation.

By the end of last year, prices were doubling, on average, every 19 days. This has left many Venezuelans struggling to afford basic items such as food and toiletries.

Venezuela once boasted Latin America’s richest economy with one of the biggest oil reserves on the planet.

But under former president, Hugo Chávez and current President Maduro, corruption, mismanagement and high levels of debt have resulted in the country’s economic collapse.

Venezuela’s economy is in shambles and the country was plunged into political chaos as a result of poor government decisions causing one of the most devastating circumstances of hyperinflation in recent times.

Dollar vs Gold

Argentina looking into the barrel of an economic crisis.

Argentina ended 2018 with the second-highest inflation figure in Latin America, behind Venezuela, as reported by the national statistics institute.

Argentina has been subject to two major currency crashes in 2018 that saw the peso lose 50 percent of its value against the dollar.

When President Macri took office at the end of 2015 the deficit in the government’s finances was large. He aimed to bring this down but adopted a gradual approach to economic reform.

For years, populist governments printed money to finance wide budget deficits, causing prices of consumer goods to spike. Macri’s government reduced that practice, but his hikes to utility prices as part of an effort to reduce subsidies and close the fiscal deficit have kept inflation high. The rapid drop in the exchange rate prompted inflation to accelerate in recent months.

In response to Argentina’s inflation surge, the Banco Central de la República Argentina (BCRA) did what all central banks do and increased up interest rates in an attempt to keep the peso from plunging and generating more inflation.

These economic woes forced President Mauricio Macri to seek aid from the International Monetary Fund (IMF), securing a bailout loan of over $50 billion.

It’s all happening under a government that was seen by the international financial markets as offering Argentina new hope, one which, under the leadership of President Mauricio Macri, held out the prospect of stability and sustainable market-oriented economic policy that could begin to reverse over a century of poor performance.

Dollar vs Gold

Conclusion:

It is clear that there are fundamental flaws with fiat currency as it is today. Due to the nature of its production and lack of intrinsic value, it makes it difficult to have confidence in its value.

The only universally accepted currency which has passed the test of time has been traditional precious metals, gold and silver. Throughout time governments and financial institutions have made attempts to back their currency to these commodities which has proved to be successful.

However, the problems with physical gold and silver, storage, security and an inability to spend divisible units has made it difficult for mass consumer adoption.

A fundamental economic principle, known as Gresham’s law, has also been a big problem facing the adoption of gold as a usable currency.

Gresham’s law states that bad money will drive out good money, which can be illustrated using gold and paper currency as an example.

Because the perceived value and nature of gold is seen as good money, people will be incentivised to hold it and save it as it is a safe and stable store of value, and spend their less valued paper currency instead.

Paired with governments overspending during periods of financial crisis, being pegged to a physical reserve made it difficult for governments to spend more than they had, resulting in the complete abolishment of the gold standard.

The Kinesis Solution:

With the tokenization of physical precious metals and the addition of a velocity-based yield, Kinesis currencies combine the best of both precious metals and blockchain technology. With the customer, reaping the reward of a continuous stream of passive income.

We felt it was unfair that money is prone to depreciation in ways we have no control over. We believe the ready-made solution has existed for thousands of years; it just hasn’t had the advantage of technology to allow it to be used in modern life – that solution is gold.

We built Kinesis to reintroduce gold as money, as a global currency that can be used in today’s electronic payments world and be spent via debit card. By uniting tried and tested gold and silver with the latest innovations in Distributed Ledger Technology [DLT] to register ownership of physical bullion in digital form, giving the user the best of both worlds.

Kinesis currencies are representative of real physical gold and silver bullion, stored for free in fortified vaults all around the world, on a 1:1 allocation. Eliminating counterparty risk and ensuring your precious metals retain their value, year after year.

Source Date:

  • http://www.goldtelegraph.com/fiat-currency-fails
  • https://www.zerohedge.com/news/2018-02-28/failure-fiat-currencies
  • https://www.econlib.org/library/Enc1/Hyperinflation.html
  • https://object.cato.org/sites/cato.org/files/pubs/pdf/workingpaper-8.pdf
  • https://www.bbc.co.uk/news/world-latin-america-46999668
  • https://www.bbc.co.uk/news/business-45451208
  • https://www.france24.com/en/20190115-argentina-ends-2018-with-second-highest-inflation-latin-america
  • https://www.reuters.com/article/us-argentina-economy/argentinas-economic-crisis-explained-in-five-charts-idUSKCN1LD1S7