Have you ever thought why the CPI (consumer price index) goes up every year? And why inflation happens? It’s a really complicated question and the reasons could mainly include demand-pull, cost-push and expansionary fiscal / monetary policy.
Generally speaking, all of them have something to do with demand and supply. The first and second reasons are relatively easier to understand: any incidents causing the change of supply/demand of specific goods will impact their price. The third reason is in the opposite way. It’s about the amount of money itself. Issuing too much money will cause too much money in the market chasing a fixed amount of goods and it will bring about inflation.
In this article, we are not going to discuss the pros and cons of inflation, but we are trying to understand why the government is entitled to print money without any consent and collateral.
Collapse of Bretton Woods System
Last time, we understood main currencies used to fix to US dollars and US dollars used to peg to the gold and if any countries would like to issue more money, they need to have same value of US dollars. It is so-called Bretton Woods System. It’s based on the trust in US government’s ability to maintain the conversion rate between US dollars and gold. It also indirectly leads to the Dollar Hegemony.
The Bretton Woods System operates successfully in 1940s and 1950s, each government in the system believes US dollars is a stable reserve currency. However, with the Japanese and European exports become more competitive than US exports, the demand for dollars become weak. Therefore, more countries wanted to convert their dollars to gold.
Around the same time, to support Vietnam war and pursue the full employment, US government increase its military spending and implement fiscal policy to promote economic stability, but the gold US held only increased marginally. Thus, there were more foreign-held dollars than the United States had gold and more are more countries started to lose their confidence in the US government’s ability to meet its obligations. The overall Bretton Woods system fell apart. This was the first time that most industrialized and developed countries adopt unanchored paper money system.
What is Fiat money?
Fiat money means the government can mint the money without holding or being backed by any commodities (usually gold). It’s based on the trust of government instead of trust on real and physical stuff. If people lose faith in the currency, the money won’t hold value anymore.
Of course, fiat money is much more flexible for government to implement monetary or fiscal policy, so it’s definitely better choice when it comes to responsiveness to the market. However, the fiat money is not backed by physical reserve, so there is no intrinsic value in it.
Take Russian Ruble for example. We know there’s a war between Russia and Ukraine, and lots of countries impose sweeping sanctions on Russia for pushing them to retreat the troops from Ukraine. Those sanctions make Russia economy collapse and no one believe Ruble anymore which make Ruble drastically depreciate by almost 40% in short period of time. Just imagine if we still live in a gold standard era, and Russia has same value of gold stored, the currency depreciation won’t happen that soon.
Next article will be discussed the difference and similarity between Fiat money and cryptocurrency. Yes. We finally get to the point — why we need to hold cryptocurrency instead of cash or we say fiat money. Stay tuned.
Reference:
Investopia
Binance
Keep reading:
Crypto series 1 — Have you ever thought what is money?
Crypto series 2 — the Evolution of Paper Money & Central Bank
Crypto series 3 — what is gold standard?
Crypto Series 4 — Fiat Money comes into existence!
