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Gold, Silver, Fiat Currencies and Real Money

Greek Silver DrachmaJuly 20, 2014 | by Steve McCurdy

 

The Origins of Money
 

Somewhere before the beginning of recorded history, man recognized the need for a medium of exchange that would facilitate the acquisition of goods and services among individuals and tribes. At various times in his early history, some strange and bizarre things were used as

 

money. Around 350 B.C., famous Greek philosopher Aristotle identified the five essential properties that a substance should have in order to become a useful and effective medium of exchange, or “money.” They were 1) Durability, 2) Divisibility, 3) Consistency, 4) Convenience, and 5) Intrinsic Value. Aristotle likely included “Intrinsic Value” as the fifth criteria realizing that any effective and useful money should also be a store of value. In Aristotle’s day gold and silver were the only substances that met all five criteria, and gold and silver coins became universal mediums of exchange. Upper left is a silver drachma that circulated in Aristotle's time.

Today, 2,300 years later, gold and silver continue to be the best forms of money that markets have ever produced. The US Constitution, in Section 10 of Article I, states that “No State shall make any Thing but gold and silver Coin a Tender in Payment of Debts.” In addition to meeting Aristotle’s five criteria required for use as mediums of exchange, gold and silver both possess other desirable properties that help make them great stores of value.
 

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Gold is the most nonreactive, the most ductile, and the most malleable of all metals. It is highly corrosion-resistant in air and water, and it does not tarnish. Silver is the best electrical and thermal conductor among all the metals, and it is also number 1 in light reflectance. Both exist in quantities that make them viable universally as money.

Paper Money and Fiat Currencies
 

The terms “paper money” and “fiat currency” are often used interchangeably, but they haveUS Redeemable Silver Certificate different meanings. Both must declared by government fiat to be legal tender, but “fiat currency” is not convertible by law into any other thing, and is not fixed in value to any objective standard. “Paper money” on the other hand, can be “fiat currency,” but it can also be converted by law into another thing, and/or it can be fixed in value against an objective standard. Until 1933, paper money in the United States was not fiat currency, because it was always convertible by law into gold and/or silver and the value of those metals was fixed by law. At right is a post-Civil War redeemable Silver Certificate.

A Brief History of Money
 

1804 US Silver DollarOn August 8, 1786, the Continental Congress authorized the issuance of a US dollar, and simultaneously approved a variety of denominations of coins and currency bills. In 1792 the Congress created the United States Mint by passing the Coinage Act. Although there was no official gold standard, all US currency bills were convertible on demand into gold and silver. Over time, the types and denominations of coins issued by the US mint changed often to reflect market price changes in gold and silver. Throughout most of the 1900s the valuation ratio of silver to gold was maintained at 16:1. At left is Silver Dollar dated 1804.

On March 14, 1900 Congress passed the Gold Standard Act, officially putting the US on a Gold Standard. Both gold and silver coins continued to be legal tender in a system known as “bimetallism.” With the exception of two temporary suspensions during World War I, the Gold Standard Act remained in force until 1933. During the Great Depression, every major world currency in the World abandoned the Gold Standard as people became distrustful of banks and demanded gold in exchange for currency. The Bank of London abandoned the Gold Standard in 1931 to avert the insolvency of the British monetary system. In 1933, FDR suspended the US Gold Standard and outlawed the private ownership of gold to end gold hoarding and to fight the severe deflation that was believed to be causing the Depression.

These measures were believed to be temporary, but they stayed in force until the Bretton US $1 Gold PieceWoods Agreement was signed on July 22, 1944. Under the Bretton Woods Agreement all world currencies were pegged to the US dollar and thus were indirectly linked to the Gold Standard. Foreign countries were able to convert their US dollars into gold at $35.00 per ounce, but US citizens continued to be prohibited from owning gold. Silver dimes, quarters, and half dollars remained in circulation through 1964*, when silver content in the coins ended.

On August 15, 1971 President Nixon unilaterally terminated the convertibility of  US dollars into gold, ending the Bretton Woods system and making the US dollar a true fiat currency for the first time in history.

Fatal Flaws of Fiat Currencies
 

In an essay in 1966 entitled “Gold and Economic Freedom,” Alan Greenspan, former Federal Reserve Chairman, wrote this:

"In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value." 

Famous French philosopher and writer Voltaire wrote this in 1729:

“Paper money eventually returns to its intrinsic value – zero!”

Wikipedia defines fiat currency this way:

“Fiat money is valueless and used as money only by government decree.”

Governments and politicians disdain the gold standard and embrace fiat currency for reasons that should be obvious given the events of the past six years. Without a gold standard central banks can issue new money without limit and for any reason, enabling governments to spend money without political consequences. This is impossible within the constraints of a gold standard because the supply of gold that underlies the system is stable and finite. In the fiscal years 2009 through 2014 (ending September 30) the US Government will have spent approximately $7 trillion more than it will have collected from tax revenues. It has borrowed that $7 trillion shortfall by issuing treasury bonds, the vast majority of which have been purchased by agents of Federal Reserve Bank with money created out of thin air. This practice is known as "quantitative easing," or alternatively as "monetizing the debt."

The system actually works like this: The US Treasury runs out of cash and cannot pay its bills (Remember hearing about “Raising the Debt Limit?”)  Congress raises the debt limit, enabling the Treasury to sell new bonds. There are no real Buyers for the new bonds, because the market is saturated. So the Federal Reserve creates new money with a simple computer entry and deposits the new money with its agent money center banks. The Banks are then instructed to use most of the new money to purchase the bonds from the Treasury. The proceeds from the Bond auction go to the US Treasury, but guess what. The Treasury is not a bank, so it deposits the Bond proceeds in its Bank, which just happens to be the same Bank that bought the bonds. So the Bank ends up with both the Bonds and the money, in the form of new deposits.

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A $1 Million 30-year Treasury Bill

Who ultimately loses in this transaction? When it comes time for the Treasury to pay interest and principal on the bonds, where will the money come from? If you guessed “taxpayers,” you win.

Summary
 

In a Congressional Hearing in 2011, former Texas Congressman Ron Paul asked Federal Reserve Chairman Ben Bernanke if regarded gold as money. Mr. Bernanke responded “No, gold is not money.”

Please let us know what you think with a comment below. Is gold money, or is fiat currency money?

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