Gov-issued banknotes used to be based on gold, so IIUC that theoretically meant you could always trade your cash for gold. And IIUC, that was also a control on inflation.
Then at some point the currency (guess I’m assuming USD but perhaps it applies to all currencies?) was no longer based on gold. People just simply trust the currency just because there are anti-counterfeit features, and perhaps because everyone else trusts it. Is that it? Is there nothing else to establish confidence in the value?
I ask because I saw a clever anti-cryptocurrency post saying something like:
1 coin of crypto = ½ unicorn horn = 1 faun hoof = ¼ vial of potion from an oni = 50 grams of fairie dust = ⅛ dragon egg = 1 Klingon tooth
Funny, but okay, he hopes to convince people that #cryptocurrency not being based on anything means it’s worthless. Couldn’t we just as well add USD to that equation, since US dollars are also not based on anything now that gold is out of the picture?
Is there nothing else to establish confidence in the value?
There are
- a bunch of US laws preventing counterfeiting,
- US laws regulating lending,
- past performance of the US economy,
- past performance of US regulators,
- past performance of US politicians (individually kinda crummy, but they’ve been pretty consistent about keeping the country stable and the US economy building wealth),
- currency held by entities other than the US government (foreign governments and corporations),
- international agreements that agree to future payments in US dollars,
- and currency held by the US ruling class.
“Everyone else trusts it” sweeps a lot of institutional dependencies under the rug. There are many vested interests in keeping the US dollar fairly stable.
This is a good list but misses the fact that the state has a monopoly on the legitimate use of force (and therefore can both tax and compel the use of the dollar). The dollar therefore represents the economic potential of ~360m affluent (globally speaking) people who are economically and democratically integrated.
Imho the biggest threat to the status of the dollar is the sense that the democratic integrity of the US is no longer unquestioned: the republican frontrunner overtly doesn’t buy the whole ‘laws’ and ‘elections’ thing. That is undermining the conditions in the paragraph above.
Yes technically there is no material object backing the US dollar (and oddly enough some think that the Wizard of Oz is an allegory for that - https://en.m.wikipedia.org/wiki/Political_interpretations_of_The_Wonderful_Wizard_of_Oz). However the main difference between crypto currencies and fiat currencies, in my opinion, is the backing of state actors. The US dollar has value because it’s backed by the US government and they can leverage the monetary supply to exert some control over things like inflation.
One of the big issues, in my opinion, with crypto currency is that there isn’t centralized control. Without the ability to regulate the scarcity of the currency crypto currencies aren’t able to easily respond to changing global factors (although some do adapt to fluctuations in activity on the block chain). That may not matter when people primarily see them as investment vehicles, but can cause significant issues when trying to use them as actual currency.
Last note: what makes gold valuable anyways? Even gold was just a placeholder for value. At the end of the day we really just want a vehicle for value that we can agree on.
Not an economist but… pretty much. Central banks sit on gold brick reserves Previous history of governmental gold confiscation
Paper money printer/ digital number on your bank account go brr
You are correct that a fiat currency has no tangible backing. However, they do have backing from governments. The USD is backed by “the full faith and credit of the US government.”
Prior to WWI, the de facto global currency was the British Pound Sterling, backed by silver reserves.
Through the tumult of WWI, the Great Depression and WWII, precious metal reserves were consolidated in the US banks. Both through transactions (e.g. buying stuff from the US) and through deposits to secure the value from falling to foreign powers during wartime.
After WWII, the US economy was the only major power that had not been devastated, so the de facto global currency switched from GBP to USD.
As the global economy grew through the 40s, 50s and 60s, it became increasingly clear that there was not enough gold in the world to 1:1 back then USD needed to facilitate trade. There were many other factors that led to this, particularly macroeconomic decisions made in the US economy and the Vietnam War.
President Richard Nixon unilaterally ended the 1:1 backing of gold in 1971.
Since then, the USD has been backed by “the full faith and credit of the US government.”
Other currencies exchange rates are relative to the USD because the balance of international trade is denominated in USD. These rates either float (i.e. allow the market to decide the rate) or are pegged (i.e. a currency’s central bank says the official exchange rate is $1:x).
There have been discussion about shifting away from the USD as the global trade currency. Some contenders would be the Chinese renminbi or the Euro because a large proportion of international trade occurs between parties whose local economy uses one of those two currencies.
However, the decision for individual countries to switch is fraught and may cause more harm than good in the short term.
Does gold really have that much value itself?
I heard a stat on BBC World News recently that 11% of the world’s gold is owned by Indian women. It’s highly regarded there. They consider it a safety net if, for example, they encounter hard times. They can sell it to get by. From there, I’m not sure if that answers the question. But it seems it’s considered a safety net not just cosmetic.
In the trading platforms gold is often linked to emotion in the market. If people anticipate a bad stock market they will cling to gold so gold increases.
