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Is Fiat Money Extinct

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IS FIAT MONEY EXTINCT? | Can Our Financial System Survive On E-Money Alone? | | Charnita E. Grandison| February 8, 2010| | MGT 5014| Dr. Bice| IS FIAT MONEY EXTINCT? Introduction There are many purchase transactions previously handled by getting in the car, driving to a place of business, and conducting business personally with a representative of the company i. e. a cashier, an account manager, a teller, etc.

Today, in this ever-evolving world of technology, this form of business in slowly fading; from the process taking money to the cash register, to calling a company and never conversing with a person, to paying a bill and never leaving your house. It stands to reason that the thought of never seeing paper money would cross the minds of many. Would it be feasible to consider the eradication of fiat money in this world of technology? Is fiat money truly extinct? This paper will discuss how fiat money came to exist and why it would be feasible to question if it is to the point of being extinct.

It will cover the emergence of e-money, which is the form of currency that is believed to replace fiat money as well as the significance of the gold standard along with the impact all of these forms of currency exchanges will have on the economy. The History of Fiat Money Before money was paper and coin-based, it was itself a commodity, or something of intrinsic value. If a clan or tribe had an affinity for a specific bead, shell or jewel, these communities would attribute a value to these objects. This might be due to usefulness, scarcity, or aesthetic appeal. Presumably, the more rare objects carried a greater value to their admirers.

In the earliest cases, commodity-based monies were traded (effectively bartered) for other things of similar value. In that sense, early monies were convertible – but only in the most basic sense. For instance, what was accepted as currency in one corner of the world, might either be extremely banal or without any worth elsewhere. Over time, in most places, precious metals became the foremost commodity-based forms of payment. Various metals would have different prescribed levels of importance: copper would have its own value, as would silver and gold. These forms of currency both had an intrinsic value, as well as a market value.

Meaning copper, for example, received for payment could be melted down and made into something else (which could presumably be traded later), or held onto and used for future payment of something else. In the West, the use of precious metals as currency led to the production of coinage (coins made from the precious metals). Used as trading devices, and units of measure, coins emerged in Mediterranean societies in the 6th Century BC. The Lydians, located in modern Turkey are credited as having produced the first stamped coins in 650 BC, and experts suggest that contemporary Ionians and Greeks used similar types of coins.

The Babylonians are credited as having developed the precursor to the modern-day economic system. The Ancient text, The Code of Hammurabi (17th century BC) standardized the currency system. It also established laws regarding money, including legal fines and interest rates. In effect, this was an attempt to arbitrate commerce. The institution of coinage led to the development of representative currencies, in the form of notes. A representative currency is one which value of an exchange of goods or services is represented on a note.

So, instead of paying for a new horse with a bucket of silver and gold coins, a note could be exchanged and the transaction completed. These ‘bank notes’ or ‘promissory notes’ were typically slips that proved a deposit into a bank, and could be signed over to other parties, much in the way a check is used today. The most famous form of representative currency is the British Pound Sterling. Formally developed in the late 17th century, Pounds were traded as currency, and backed by a promise to the carrier they were redeemable for gold upon the bearer’s request. A one-pound note, was therefore redeemable or one Troy ounce of gold. This was also the beginning of the gold standard incidentally, which lasted until the nineteenth century in the UK, and elsewhere through the mid-twentieth century. During this time, the notes in circulation did not exceed the gold in reserves – the strength of the currency relied on the fact that notes could be exchanged at a bank by the bearer, or that they were, as the saying goes.. as good as gold. As mentioned above, representative currencies lasted until the mid-twentieth century, and since then the global economy has consisted of a number of fiat monies.

A fiat currency is one declared by a government to be legal tender – and is accepted as such. Latin for “let it be”, fiat currencies are not backed by a standard – they are simply money because the powers that be say it is to be accepted as currency. Its strength lies solely in faith in the currency, and trust that the government will not induce hyper-inflation by printing money to pay off debts. Following the basic rule of supply and demand, if there is a surplus of anything, it is less dear and thus of lesser worth.

So if a country decides to print more money for its own reasons, each existing note already in circulation theoretically becomes less valuable. Because fiat money has no backing, it cannot be exchanged for gold or silver. Historically, governments have switched to fiat, either due to recession, a war-induced strain on reserves, or by ‘running the presses’ – which meant printing additional money to cover deficits and debts. In 1971, with the fiscal strain of the Vietnam War, the US declared the dollars in circulation exceeded the amount of gold in reserves, and therefore the US would no longer be backed by silver/gold standard.

This would mark the end of the post-war Bretton Woods System wherein the world’s currencies were pegged at against the US dollar, which was fixed vis-a-vis silver and gold. In that sense, other currencies were of a fixed price as well (with a +/- 1% variation based on demand). Because the dollar was and remains not only the most widely-circulated currency and the currency against which other nations valued their own, all of the world’s currencies in effect became fiat-based. Today, all currencies are fiat-based. Many economists have expressed concern ver the sustainability of such a system based on trust in a hegemonic currency, the US Dollar. The rise of an increasingly global economy, with the strength of the European Union and China at the fore, combined with the recent US-led recession has caused foreign reserve banks to trade in their Dollars for other currencies. The Emergence of E-Money The development of information technology and the emerging of a number of new innovations are taking place in the area of retail payments known as electronic money (e- money).

This development influences the banking industry due to the increased use of pre-paid card, e-purse, and ewires of money orders, e-banking, e-loans. These innovations have the potential to challenge the predominant role of cash for making small value payments and could make retail transactions easier and cheaper for consumers and merchants. Various e-money schemes are being developed and they differ considerably in their features, many aspects of which are still to be finalized (Bernkopf, 1998). Firstly, e-money products differ in their technical implementation.

To store the prepaid value, card-based schemes involve a specialized and portable computer hardware device, typically a microprocessor chip embedded in a plastic card, while software-based schemes use specialized software installed on a standard personal computer. Secondly, institutional arrangements may vary. Typically, four types of service provider will be involved in the operation of an e-money scheme: the issuers of the e-money value, the network operators, the vendors of specialized hardware and software and the clearers of e-money transactions. Thirdly, products differ in the way in which value is transferred.

Some e-money schemes allow transfers of electronic balances directly from one consumer to another without any involvement of a third party such as the issuer of the electronic value. Fourthly, related to transferability is the extent to which transactions are recorded. Most schemes register some details of transactions between consumers and merchants in a central database, which could then be monitored. In cases where direct consumer-to-consumer transactions are allowed, these can only be recorded on consumers’ own storage devices and can be monitored centrally only when the consumer contacts the e-money scheme operator.

Finally, in most e-money schemes currently being developed or pilot-tested, the “value” stored on the devices is denominated only in the national currency. It is possible, however, for balances to be held and payments to be made in several different national currencies. Advantages and Disadvantages of Fiat Money The circulation of fiat money may lead to inflation, whereas money redeemable in gold or other securities is held much less likely to do so. Under conditions of proper monetary management, however, fiat paper money can be a stable currency. In fact, contemporary American money is essentially fiat money.

All Federal Reserve notes and most circulating coins are money because the government says they are, not because they are backed by precious metals. Fiat money threats have one foundational risk, human, whether it is greed or error. Usually, a fiat-money currency loses value once the issuing government refuses to further guarantee its value through taxation, but this need not necessarily occur. For example, the so-called Swiss dinar continued to retain value in Kurdish Iraq even after its legal tender status was withdrawn by its issuer, Iraq’s central government. (Foote) Advantages and Disadvantages of E-Money

E-money threats include different elements and not all can be avoided. The environmental element such as natural disasters is not an entity that can be controlled nor can anyone be held accountable for its results. The technological element such as computer error is an element that can be controlled but definitely not eliminated and although someone could be held accountable, more than likely, it would be considered the “norm”. Although digital cash can provide many benefits such as convenience and privacy, increased efficiency of transactions, lower transaction fees, and ew business opportunities with the expansion of economic activities on the Internet, there are many potential issues with the use of digital cash. The transfer of digital currencies raises local issues such as how to levy taxes or the possible ease of money laundering. There are also potential macro-economic effects such as exchange rate instabilities and shortage of money supplies (total amount of digital cash versus total amount of real cash available, basically the possibility that digital cash could exceed the real cash available).

Another issue is related to computer crime, in which computer criminals may actually alter computer databases to steal digital cash or by reducing an account’s amount of digital cash. One way to resolve these issues is by implementing cyberspace regulations or laws that regulate the transactions and watch for signs of fraud or deceit. Money and the Economy Money is essentially a good, so as such is ruled by the axioms of supply and demand. The value of any good is determined by its supply and demand and the supply and demand for other goods in the economy.

A price for any good is the amount of money it takes to get that good. Inflation occurs when the price of goods increases; in other words when money becomes less valuable relative to those other goods. This can occur when: 1. The supply of money goes up. 2. The supply of other goods goes down. 3. Demand for money goes down. 4. Demand for other goods goes up. The key cause of inflation is increases in the supply of money. Inflation can occur for other reasons. If a natural disaster destroyed stores but left banks intact, we’d expect to see an immediate rise in prices, as goods are now scarce relative to money.

These kinds of situations are rare. For the most part inflation is caused when the money supply rises faster than the supply of other goods and services. Money has value because people believe that they will be able to exchange their money for goods and services in the future. This belief will persist so long as people do not fear future inflation. To avoid inflation, the government must ensure that the money supply does not increase too quickly. In a fiat monetary system, there is no restrain on the amount of money that can be created. This allows unlimited credit creation.

Initially, a rapid growth in the availability of credit is often mistaken for economic growth, as spending and business profits grow and frequently there is a rapid growth in equity prices. In the long run, however, the economy tends to suffer much more by the following contraction than it gained from the expansion in credit. In most cases, a fiat monetary system comes into existence as a result of excessive public debt. When the government is unable to repay all its debt in gold or silver, the temptation to remove physical backing rather than to default becomes irresistible.

This was the case in 18th century France during the Law scheme, as well as in the 70s in the US, when Nixon removed the last link between the dollar and gold which is still in effect today. Hyper-inflation is the terminal stage of any fiat currency. In hyper-inflation, money looses most of its value practically overnight. Hyper-inflation is often the result of increasing regular inflation to the point where all confidence in money is lost. In a fiat monetary system, the value of money is based on confidence, and once that confidence is gone, money irreversibly becomes worthless, regardless of its scarcity.

Gold has replaced every fiat currency for the past 3000 years. The United States has so far avoided hyper-inflation by shifting between a fiat and gold standard over the past 200 years. Conclusion The convenience of conducting transactions without leaving home or office settings has proved to catapult the use of e-money by consumers as well as businesses. But, to consider abandoning the fiat money society for the volatile e-money world is conceivable but disturbingly irrational.

As in the case of the tragic September 11th bombings of the Twin Towers in New York City, the exclusive use of e-money could bring this country to its knees. Although e-money is a very convenient means of exchange and exhibits the element of speed, it has the potential to pose many threats to the financial operation of this society to include security, electronic, and operational risks, just to name a few. Fiat money is not without risk; examples are armed robbery, loss, and theft. There is one prevalent disadvantage posed by fiat money as well as e-money; inflation.

E-money will definitely have an effect on the economic system but through research, the conclusion is that fiat money will be around for a very long time. The e-money system is a less expensive system but until the system is more stable, it will not be the exclusive transfer of funds for the economy. REFERENCES Foote, Christopher; Block, William; Crane, Keith ; Gray, Simon (2004), “Economic Policy and Prospects in Iraq”, The Journal of Economic Perspectives 18 (3): 47–70. Budget and Finance (2003). “Iraq Currency Exchange”. The Coalition Provisional Authority. http://www. cpa-iraq. org/budget/IraqCurrencyExchange. html.

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