“Paper money eventually returns to its intrinsic value — zero.”
Voltaire
Fiat means “by decree” or “let it be done”, in the context of money a fiat currency is decreed and backed by a state/autocrat who exercises the force-backed laws needed to demand its use. The oldest fiat money in circulation is the British pound, issued since the Bank of England’s founding in 1694. The case of the Bank of England seems to be the exception to the rule, this modality of money has been used throughout recorded history, and time and time again it has shown a similar pattern that ultimately leads to failure. This seems to be the explanation of why, on average, fiat currencies have a short lifespan.
A study conducted in 2009 analyzed the data of 775 fiat currencies worldwide and found that 20% of them failed due to hyperinflation, 21% destroyed in war, and 24% reformed through centralized monetary policy. With this data, we can synthesize several plausible conclusions: failure or discontinuance of fiat is triggered by government intervention, warfare, and economic policy.
Economic policy
“The most important thing to remember is that inflation is not an act of God, that inflation is not a catastrophe of the elements or a disease that comes like the plague. Inflation is a policy.”
Ludwig Von Mises
The effects of the economic policies behind fiat currencies are designed to be inflationary. Even the oldest and most stable fiat currency, the British pound, shows this pattern: compared to its initial worth in silver in 1694, it has lost almost 100% of its value up to this day. The dollar is not the exception, $1 of 1913 has $26.29 of purchasing power in 2020. It can be understood the other way around, 1 dollar through time 1913–2020:
The comprehensive data of fiat currencies indicates that their price almost always tends to zero in time. With its ability to print more money than that which it can back up, the fractional reserve banking system generates money out of thin air that ultimately goes into debt, devaluating the overall money supply. These policies seem to exacerbate a systemic failure in the model that generates a cycle of debt and wealth erosion for the many, wealth that invariably goes into the hands of a privileged few.
There is a strong case to be made that some form of commoditization occurs, and paper money acts as a tangible commodity. This commodity is then concentrated in the hands of the ones who issue it, issuing more than that which they can back up, flooding the economy in debt, which ultimately cannot be repaid. This then becomes an opportunity for real wealth extraction and transfer into privileged elites’ hands during the inevitable crisis.
In the end, the data seems to indicate that a small portion of the population accumulates the majority of hard assets, stocks, bonds, tax breaks, using fiat as a means of acquiring real wealth. Meanwhile, the majority experience fiat money as debt, direct taxation, inflation, and currency devaluation as indirect taxation.
Monetary policy as rent extraction and wealth erosion.
“By this means(fractional reserve banking) government may secretly and unobserved, confiscate the wealth of the people, and not one man in a million will detect the theft”
John Maynard Keynes
Through globalization, the modern international monetary system has been extremely successful in bringing prosperity and overall raising standards of living across the globe. Nonetheless, the flaws of the central bank model have been gamed continuously throughout history. The boom/bust cycles some policies generate in the economy have always been exploited by actors who, whether by design or opportunity, corrupt the system instituting a rent extracting model of wealth erosion and transfer that stagnates innovation and creates vicious impoverishment cycles.
A significant number of cases can be mentioned, going back all the way to England around 1750 when property rights enabled land to be used as collateral for projects. This was an important step that significantly fueled growth. Still, it can be argued that through time and monetary policy, sudden spikes in the interest rate generated defaults on payments and hard asset forfeiture in favor of a privileged few. This pattern repeats itself throughout history, with the most recent case being the 2008 crisis.
Hyperinflation
“Inflation is taxation, without legislation”
Milton Friedman
Hyperinflation has been a widely studied phenomenon. It’s been a recurring issue in modern financial history, and many cases can be mentioned. One example is what happened to the German mark in 1914 when it abandoned the gold standard only to succumb to hyperinflation 10 years later. The Hanke-Krus “World Hyperinflation” study shows the variety of hyperinflation events experienced since 1945, highlighting the economic perils that nations worldwide have faced. Various essential lessons can be learned through the data. Still, the end result is the same: disastrous economic policies derived from irresponsible actors have impacted populations’ stability and well-being worldwide. Below you will find an excerpt from the study:
Traditional financial systems rely on central authorities that dictate economic policy based on the fiduciary trust that society places in them. In a perfect world, central authorities act in good faith and dictate policies that factor in the complexities behind the economy to the best of their ability. But the reality is that these central authorities face several challenges during policy decision-making, such as the irrationality of economic agents, foreign and domestic government policies, and the trustworthiness of data required for policy decision making, to mention a few them.
For this essay’s purpose, we will concentrate on one factor: reliability and value of the data used for policy decision making. An important thing to consider is that most of the economic data from which central authorities derive policy are not provided to them in real-time; the data comes from a different temporality and is always out of phase. The consequence of this is that they never have a “real picture” of the economy and institute policy based on outdated data. These policies take a long time to make the desired impact on the economy. In the end, they can only make approximations, or one could argue almost educated guesses and with this data model the economy and dictate policy.
Factors behind the time rate of data collection and the time it takes for the policies to produce the desired results can be attributed to outdated technologies used by central trusted authorities, such as cash, traditional accounting methods & the numerous trusted agents that comprise the system. Most of these factors can be significantly mitigated or eradicated with a transition towards better technologies. Still, there is one factor that cannot be mitigated, the model’s reliance on trust. This factor will always be a flaw that can be exploited by corrupt, negligent, irresponsible, or, to put it simple: fallible agents.
Bitcoin and the rise of the era of private programmable money
“What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party.” — Satoshi Nakamoto(From the Bitcoin whitepaper)
With Bitcoin, Satoshi Nakamoto’s gift to the world came as a solution to a problem encountered ever since Fray Luca Pacioli defined modern accounting rules in 1494: The solution to the double-spending problem. The problem was solved via an electronic economic system implemented through a distributed ledger(or distributed store of data), decentralized control & consensus that relies on cryptographic proof instead of trust. Giving rise to the birth of a new asset class, one that can have economic scarcity(or not) encoded into it, can be sent anywhere in the world without the need of intermediaries, for a fraction of the cost of traditional finance transfers. With the crypto asset class, a wide range of possibilities opened up for private/public collaboration.
Blockchain is the underlying technology behind Bitcoin. Today with blockchain technology, most of the issues that central bankers face can be tackled. This is the reason they are currently exploring technology and its use cases. The rise of the crypto asset class is a referendum on these actors’ accountability throughout the world. There is still a lot of work to do.
With the Gaugecash protocol, we are developing a decentralized monetary system backed up by the blockchain asset class itself. It can act as a store of value or medium of exchange and as a tool that can provide data in real-time to central monetary authorities while protecting end-users’ privacy.
This is part of a series of essays we will be posting soon. Follow us on social media and stay tuned for more information on decentralized finance, crypto assets, and blockchain technology.
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