The first gold coins appeared around 560 B.C. Over time it became a practice to store larger amounts of gold in warehouses. Paper receipts were issued certifying that the gold was on deposit. These receipts were negotiable instruments of trade and commerce which could be signed over to others. They were not actual currency but are a presumed forerunner to our modern checking system.
Gold is original money. It was money before paper receipts were issued. The paper receipts were not money. They were substitutes for real money. Today, all paper currencies are substitutes for real money.
The term ‘fiat money’ comes up often and is used in financial and economic analysis, commentary. Definitions are offered, but they vary somewhat in accuracy and clarity, and tend to be incomplete. In some cases, the explanations leave us with a vague understanding of the term and its applicability.
The specific definition that I find to be the most accurate and complete is as follows:
“ fiat money is inconvertible paper money made legal tender by a government decree”
There are no less than four separate terms in the above definition, each with its own respective definition, which are critical to a complete, accurate, and clear understanding of fiat money. They are: 1) inconvertible 2) paper money 3) legal tender 4) government decree. Let’s examine each one.
One definition of inconvertible is “not able to be converted into another form of money on demand”. That is mostly accurate but it is not specific enough for our purposes. From “History Of Gold As Money“…
As late as the early twentieth century, the U.S. dollar was fully convertible into gold at a rate of twenty ($20.67) dollars per ounce. You could exchange paper currency of twenty dollars for one ounce of gold, usually in coin form; and vice-versa. The two were interchangeable and the either one was payable on demand.
In 1933 President Roosevelt issued an executive order “forbidding the hoarding of gold coin, gold bullion, and gold certificates within the continental United States”.
A better definition of inconvertible would be “not able to be exchanged (converted) into gold (i.e., real money) on demand”.
A basic definition of paper money is “money in the form of banknotes”. All paper monies are substitutes for real money/gold. They have no intrinsic value.
The definition of legal tender is “banknotes that must be accepted if offered in payment of a debt”.
And, finally, the definition of government decree is “a rule of law usually issued by a head of state…”. They are authoritarian in nature.
Now let’s look at the U.S. dollar:
There is no statement which guarantees that the dollar can be exchanged for gold (real money) on demand. Nor can it be exchanged for any other form of money. In any sense of the word, the U.S. dollar is definitely inconvertible. Don’t confuse currency exchange or purchases of gold on the open market for convertibility. There is no link of any specific quantity at any fixed price for any other form of money.
Not only is the U.S. dollar inconvertible, it is also irredeemable. The definition of irredeemable is “not able to be saved, improved, or corrected; paper currency for which the issuing authority does not undertake to pay coin”. In this case ‘coin’ refers to real money/gold. Both definitions apply.
(Some might argue, and have, that the dollar can be saved. In a certain very technical sense, that may be the case. However, what is necessary in order for that to happen would not be allowed. It would require financial and economic pain, the likes of which would require depression-like conditions, before the welcomed stability and prosperity. Unfortunately, we may experience worse results by continually postponing any healing crisis.)
At the top of the image above, and on the dollars which we use, are the words “Federal Reserve Note”. The Federal Reserve is a bank. It is a banker’s bank. It is also a central bank. Hence, the U.S. dollar is a banknote. And it is printed on paper. As such, it meets the definition of paper money.
In the top left section, directly underneath “THE UNITED STATES OF AMERICA” is the declaration: “THIS NOTE IS LEGAL TENDER FOR ALL DEBTS, PUBLIC AND PRIVATE“. So, we have a “banknote(s) that must be accepted if offered in payment of a debt”.
Both President Roosevelt and President Nixon, in their government decrees (executive orders) suspending convertibility of the U.S. dollar, also proclaimed and declared the use of the U.S. dollar as legal tender, and the declaration is backed by force of law.
Convertibility is the key. It is unnecessary to force people to accept paper money when it is redeemable on demand for a known and specific quantity of gold.
Unfortunately, government cannot be trusted. Which is why, even with convertibility, the U.S. dollar’s link to gold was eventually severed. Here’s why.
For convertibility to work, the supply of banknotes needs to remain stable. As more paper money is issued, the ability to redeem on demand declines. Some would say that the paper money loses value. Yes, but the only real value to the paper money is its convertibility into gold.
As questions arose regarding the value of the paper money in circulation, more and more people opted for real money – gold. There simply wasn’t enough gold to meet the redemption demands. And to whatever extent it was available, the banks and the government didn’t want to release it. Again, from “History Of Gold As Money“…
In 1968, the United States Government again revalued gold “officially” at $40.00 to the ounce and at the same time acknowledged a “free-market” price for gold which could operate on its own, independently. However, the U.S. would not recognize the free-market price in any official dealings/transactions.
By 1971 things were getting a bit dicey. Foreign governments wanted their gold, but the U.S. did not want to release it. Or, they didn’t have it. Probably some combination of both. So, in August 1971, President Nixon suspended any further convertibility of U.S. dollars into gold by non-U.S. citizens. All hell broke loose. Literally.
Gold is real money. And it is original money.
What we call money today is really just paper. And the U.S. dollar is the epitome of fiat money.
Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED!