posted on Apr, 28 2018 @ 04:28 PM
While our currency is typically seen as fiat, it actually is not completely fiat. By fiat, I am referring to the fact that a dollar can no longer be
exchanged on demand for a pre-specified amount of gold or silver. That is no longer possible, but for some time the concept of a backed currency has
still been present in our currency.
It is true that backing currency with physical commodities can have the effect of limiting growth capacity on an economy. The only way this can be
overcome is by leveraging, which is similar to the multiplier effect so thoroughly debated above. That has one massive issue, however: if too many
people decide to cash in their backed currency at the same time, it becomes quite possible that there will too little of the backing commodity to
cover the demands and the backed currency becomes fiat overnight.
The concept of backed vs. fiat, however, goes back to the issue of confidence in a currency. For a currency to be valid, there must be confidence that
the currency will be worth tomorrow what it is worth today (or at least close to it). Otherwise, who would accept currency as payment if there is no
confidence that it will have value tomorrow when needed? Obviously no one. Thus, the real backing of the dollar among the population is based on the
fact that the United States has a stable economy that will operate on the dollar tomorrow, next week, a year from now, ten years from now, and so
But... that is how the population sees it. Most people do not care about the intricacies of international currencies. They are too busy getting to
work and back and trying to enjoy what little free time they have. As long as they know that their paycheck will cover the utility bills at the end of
the month and they can purchase a meal or a movie ticket with their dollars, all is well with the world.
From a higher viewpoint, that of nations and the uber-wealthy, things get a little more complex. While a US citizen can have complete faith in the
currency their government backs, another nation may not. China wants value for its products. China is interested in making sure that its currency is
stable so its population can live without revolt or retreat from its borders. After all, that is the goal of any government: to exist and rule. Revolt
and a decreasing population is antithetical to this goal.
So the Chinese government will artificially adjust its currency to try and compete with other currencies like the American dollar. If it has no faith
that the dollar will have value tomorrow, the value of Chinese currency will rise compared to the dollar. That will trickle down to the general
population and cause US goods to be cheaper than Chinese goods, because it will be cheaper from the Chinese standpoint to purchase dollars. this is
how the economy naturally adjusts to currency values.
Unless the dollar becomes worthless. At that point, things change.
Consider this simplified example: let us say the dollar is worth the same as the yuan (the Chinese equivalent of our dollar). If an item in China
costs 10 yuan, it also costs ten dollars. Somewhere, someone is trading in currencies, so this person will happily trade 10 yuan for ten dollars, as
long as they get an extra dime for their trouble (I am assuming 1% trading fee). So the person living in China can buy a Chinese product for 10 yuan,
or an American product for 10.1 yuan. They don't care about the dollars; they get paid in yuan.
Now if the traders decide they don't have as much faith in the dollar, they will consider the yuan more valuable, let's say 1 yuan is now worth $1.10.
So the $10 from America now costs them 9.091 yuan, plus their 1% profit. The American product now sells for 9 yuan as compared to 10 yuan for the
Chinese product. Obviously, more Chinese will buy the American product, which means the American economy strengthens, and the value of American
currency rises again compared to the yuan.
If the American currency appears to be in danger of collapsing, however, the traders are not going to pay anything for the dollar! They want something
they can trade tomorrow and next week and next year and whenever they need to. At that point, it becomes hard to find American products in China,
because no one is willing to trade currencies. That's why the Confederate dollar is worthless today; no one will trade for it, because it's not backed
by anything, not even a country.
With backed currency, this never happens, because the currency can always be converted to something that has value. But with fiat currency, it becomes
a real danger, especially for those who live in the country where the currency is dropping. They lose access to products made abroad. In the previous
example, that Chinese good that originally cost $1.10 in America now costs $1.20. As the currency depreciates, that cost rises and can become
astronomical, meaning no one in America can buy Chinese products. The Chinese have the lion's share of the world's rare earth metals, required for
high technology. So not being able to access those materials means the American economy cannot produce high-tech products. That further depresses the
American economy, and makes the matter worse.
But, as I will explain further, we do not have a fiat dollar in international relations.