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Fiat Money
Today, all national currencies are fiat currencies.
What exactly is fiat money?
This term derives from the Latin word fiat, simply meaning “Let it be done”
Fiat money is a currency that a government has decreed by law to be the legal tender of that country and to be used for all financial transactions, despite the fact that it is has no intrinsic value on its own and is not backed by physical reserves.
Fiat money appears intermittently throughout recent history. One of the first uses of fiat money (called greenbacks) was in 1862 in the United States. It was used as a tool to fund the enormous cost of the Civil War. This money was a debt of the government, redeemable in gold at a future but unspecified date.
With the advent of War World I, many countries involved in the war from 1915 – 1925 had to print a lot of paper currency to support and pay for the war efforts. De-linking the currency from the then gold standard was a necessity as there was simply not enough gold or silver to back the amount of currency being printed.
After the Great Depression from 1931 to 1945, fiat currencies reigned worldwide causing huge imbalances from country to country. These imbalances, closed market policies, economic manipulation and economic warfare were major contributing factors to the beginning of the Second World War.
Fiat money and inflation
With fiat money, there will always be inflation.
There are serious consequences if too much money is printed and injected into an economy without restraint, compounded by bad government policies or politics. This can lead to rapid devaluation of the currency and result in hyperinflation.
During the Japanese occupation of Singapore, Malaya, North Borneo, Sarawak and Brunei in the Second World War, a new fiat currency was introduced by the Imperial Japanese to replace the Straits or Malayan dollars. These new notes were known as “banana money” because of the motifs of banana trees on its $10 notes.
To supply the ruling authorities with money whenever needed, the printing presses simply kept printing more and more banana notes.
Without an identifying serial number on the notes, counterfeiting was rampant and a glut in money supply resulted in hyperinflation and a severe devaluation of the banana notes.
To keep up with hyperinflation, notes of larger denominations were printed and circulated. After the Japanese surrendered in 1945, the currency became entirely worthless.
In the case of Zimbabwe, years of bad monetary policies, unrealistic borrowings, massive corruption and dictatorial politics have plunged the country into severe debt and poverty.
In the early 2000s, shortly after Zimbabwe’s state sanctioned confiscation of white-owned farmland and its repudiation of debts to the International Monetary Fund (IMF), hyperinflation kicked in at a savage pace.
To counter this, the Zimbabwe’s government simply printed more and more money with bigger and bigger denomination leading to astronomic hyperinflation.
The Reserve Bank of Zimbabwe (RBZ) issued a ZWD $10 million dollar note in January 2008, roughly equivalent to USD $4 dollars. In April, a $50 million dollar Zimbabwean note was issued, but now worth roughly USD $1.20. On the 19th of July 2008, the RBZ announced plans to introduce a ZWD $100 billion bank note.
11 days later, the Governor of the RBZ, Gideon Gono announced a redenominated dollar by removing 10 zeros, effective by the 1st of August. This effectively meant that ZWD $10 billion dollars will become ZWD $1 dollar after this redenomination.
Here a quick look at the rise of inflation in Zimbabwe’s history.
Courtesy of Wikipedia
Official statistics reported in October that year that Zimbabwe’s annual inflation in July 2008 was 231 million percent and annual rate of price growth was 11.2 million in June.
On the 16th of January 2009, RBZ announced plans for the imminent issue of bank notes of $10 trillion, $20 trillion, $50 trillion and even $100 trillion (ZWD $100 trillion was valued at $USD 30 at that time). An interesting challenge was how to put all the zeros in the new notes.
Less than 2 weeks later, in an effort to curb the country’s runaway inflation, the government announced that other, and more stable currency like the South African Rand can be used along with the Zimbabwean bank notes.
The reality was not even street vendors at that time were willing to accept Zimbabwean dollars as payment due to this crazy hyperinflation.
Finally, on April 12, the Zimbabwean currency was suspended and all trade was made in foreign currency, including the US dollar, UK pound and South African Rand.
These days, fiat money is being printed and injected in massive amounts into major economies like never before. It is estimated that every single day, USD $4 billion is pumped into the global economy as a result of the Quantitative Easing II (QE2) policy adopted by the Federal Reserve to inject liquidity and encourage economic growth in the United States.
In a fiat monetary system, there is no restraint placed on the amount of money that can be issued, very much like the banana or Zimbabwean bank notes.
As all money is created from the issue of credit from banks, the fiat money supply expands exponentially as people and government get into debt by borrowing more and more money.
On the surface, a rapid expansion of credit availability may seem to be a sign of economic growth and a prosperous future since money is in such abundance, but in reality; the ever increasing debts will simply lead to economic disaster in the long term.
As explained above, a negative and unavoidable by product of fiat currency is inflation. The more fiat money in the system, the less it is worth. With fiat currency being created by the hundreds of billions each year by central banks, we are unfortunately heading towards a major global currency re-evaluation, some time in the near future.
To put fiat money into its proper context; fiat money is not real money. Fiat money is simply a tool endorsed by the government as legal tender, an object in transactions. Fiat money is only as good as the people’s faith in it.
The real money is and always will be silver and gold.
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