1) The rationale is that silver is significantly harder to create, while paper notes are easy. If the paper notes must be redeemable for silver, it is some level of control on the creation of paper notes, in that a rational economic actor is unlikely to create significantly more notes than they can redeem. Austrian Business Cycle Theory places the blame for the business cycles firmly on the creation of unbacked paper currencies and the resulting inflation. Most people calling for sliver (or gold for that matter) backing of the US dollar subscribe to ABCT, and believe that such backing would reduce or eliminate the damage done by business cycles.
Thanks, I think I follow this explanation to some degree.
Here is what I still don’t get: What is special about the silver? Instead of limiting the money supply by linking it to silver, why not just choose an arbitrary number of dollars and say, “that’s the limit?” It seems to me that the quantity of silver is limited and arbitrary, so I still don’t understand what the advantage would be for using silver backing.
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Can’t we look into precommitment mechanisms (I am skeptical of the current batch of crypto$, but crypto seems like a good field to look into for precommitments).
Yes, it’s arbitrary. On the other hand, governments historically have a mixed track record at keeping their word when they promise not to wreck the currency. It’s easy and tempting to cheat if there isn’t some physical limit to expanding the money supply.
I understand and agree with what you and Lumifer (below) say about how it’s easy to “cheat” if you don’t have a physical limitation on the money supply.
However, wouldn’t it be just as easy to change your mind with the physical backing: “Now you pay two dollars to get an ounce of gold, whereas in the past you paid one dollar per ounce of gold.”?
I guess to get to the crux of the matter—does the fact that there is a physical/concrete/non-abstract component involved sufficiently blind people to the fact that inflation could still happen under this system that it once proved effective for preventing mass loss of confidence?
However, wouldn’t it be just as easy to change your mind with the physical backing: “Now you pay two dollars to get an ounce of gold, whereas in the past you paid one dollar per ounce of gold.”?
Governments can indeed do this—the usual term is “devaluing.” But a devaluation is a blatant obvious politically costly thing, in a way that letting inflation gradually creep up from 2% to 4% to 8% isn’t. So it’s not “just as easy.”
No. There isn’t. There are many bad rationales for metal-backed currencies, but as a practical matter given the relative sizes of modern economies and the sizes of precious metal reserves, any such setup would have to be absurdly leveraged
Meaning that there would be very little actual metal backing the theoretical convertibility, so it would be vulnerable as all hell to runs. The smallest twitch of panic in the markets would utterly exhaust the actual reserves, so the backing would be a lie.
Or alternatively the price on the precious metals would have to be so absurdly high that the distinction between a mine and a printing press would be utterly meaningless.
Very rough numbers pulled from wikipedia: in order for the value of silver reserves to equal gdp the price of silver would need to hit.. (90 trillion gross world product /540,000 tonnes of silver) .. about 5000 dollars/troy ounce at which point the currency can be debased by mining more silver because the price of doing so would be 2 orders of magnitude less than the value of the metal. And this would in fact instantly start happening unless you outlaw silver mining. Effectively that would be legal currency printing for anyone with a silver mine. Hello inflation.
1) Distinguish between government and individual use of value-tokens. For individuals, money can be traded for silver at many shops, and silver for money at some of them. Of course, there are probably better stores of value than either USD or shiny metal (I might suggest productive working capital in the form of equipment, education, stocks/bonds, or other investments).
2) Anyone who uses the phrase “intrinsic value” is at least 50 years out of date in their microecon thinking—http://en.wikipedia.org/wiki/Marginalism is a good intro to a more modern (and in fact more true—it fits actual data a lot better) theory.
Yes, there is a rationale for having a commodity-backed currency.
Fiat currency has a failure mode in which there’s a self-reinforcing mutual lack of confidence. If I think that the Ruritanian Lira is wastepaper, I will try to get rid of my Lira—I will spend as fast as possible. And this is inflationary. And once other people see the inflationary pressure, they also will head for the exits. Purely fiat currencies can go effectively to zero within a period of a few years—particularly if they are backed by a weak government that isn’t reliably able to force people to accept and use the currency.
With metal or other commodity currencies, there’s a floor on that process. Whatever you think of the Ruritanian government, you can use silver for jewelry, wiring, and so forth. Silver does have an intrinsic value separate from its use as a currency. Put another way—if the currency depreciated badly enough, people would limit the money supply by melting down the silver and using it for wiring, and that would limit the inflationary pressure.
That doesn’t necessarily make silver currency a good idea or even a good investment—it might happen that the market-clearing price, if you ignore the currency uses, leaves a lot of room for depreciation.
I think that you’re kind of getting at my thinking: the fact the silver has other uses might be a psychological stabilizer, to prevent or slow the self-reinforcing mutual lack of confidence.
This is (I think) what I’m trying to tease apart—that the economy might benefit from this comfort people feel, but in a more “rational” evaluation, the silver backing isn’t necessary.
Purely fiat currencies can go effectively to zero within a period of a few years—particularly if they are backed by a weak government that isn’t reliably able to force people to accept and use the currency.
Which governments force people to accept and use their currency? If I hire a plumber to clear my drains, I can legally pay him with whatever we can both agree on. If I have something to sell, no law obliges me to state a price or accept offers in money. Money is just the most convenient way to do these transactions. My country uses pounds, but there is no law stopping me from opening a bank account denominated in dollars, and shops in London often accept euros. The Truck Acts are the closest thing to a requirement on anyone to use money, but were enacted for the protection of workers, not the support of the currency .
Someone linked to this article, which links to this article describing how bottles of Tide detergent are being used as money. The people involved are committing many offences, but using Tide as money is not one of them. It is also clear from the latter link that the claim in the former that “all currency is fiat currency” is wrong. Tide is not fiat currency. It only gets to be used as a medium of exchange because it is valued as detergent. The subjectivity of value has nothing to do with the concept of fiat currency.
Which governments force people to accept and use their currency?
All of them. Try paying your taxes in anything else other than pounds.
All governments force people to use their currency for certain transactions, but most allow the use of other currencies (or other methods for settling transactions) as well.
If taxation is all you can find to support the idea of governments forcing their fiat money on the people, it’s not much of a case.
I don’t see any need for a case. Looking at the world empirically, I see governments everywhere having a lot of success in “forcing their fiat money on the people”. Even in the third world where not infrequently there is a parallel currency (like USD or EUR) in circulation, the local currency is still being actively used. For one, the government pays in it so if you work for the state or you’re a business which sold something to the state, local currency is what you get.
What else would I use anyway? Tobacco? Farm produce? Old Master paintings? Oh, actually, all of those have been used at various times and places.
You’re certainly right that some governments, some of the time, allow payment in-kind and don’t impose a currency. Most modern governments, however, do require you to pay your taxes in the national currency. Can you pay HMRC in anything other than UK pounds?
(Edit: As gwern notes below, this was repealed about 40 years later; my point was that the government can de facto stop you from using Gold or Silver as a medium of exchange, if they so wish)
Such gold clauses were intended to protect against the United States devaluing the dollar. When the Emergency Banking Act of 1933 and the Gold Reserve Act of 1934 outlawed the use of gold, such contracts became sources of controversy. In the gold clause case Norman vs. Baltimore & Ohio Railroad Co., 294 U.S. 240 (1935), the U.S. Supreme Court ruled that gold clauses were invalid. However, Congress later reinstated the option to use gold clauses for obligations (new contracts) issued after October 1977 in accordance with 31 U.S.C. § 5118(d)(2). The 2008 decision 216 Jamaica Avenue, LLC vs S&R Playhouse Realty Co.[3] established that a gold clause in contracts signed before 1933 was only suspended not erased, and under certain limited circumstances might be reactivated.
The limitation on gold ownership in the U.S. was repealed after President Gerald Ford signed a bill legalizing private ownership of gold coins, bars and certificates by an act of Congress codified in Pub.L. 93–373[6] which went into effect December 31, 1974. Pub.L. 93-373 did not repeal the Gold Clause Resolution of 1933, which made unenforceable any contracts which specified payment in a fixed amount of money or a fixed amount of gold. That is, contracts remained unenforceable if they used gold monetarily rather than as a commodity of trade. However, the Act of October 28, 1977, Pub.L. 95–147, § 4(c),[7] amended the 1933 Joint Resolution and made it clear that parties could again include so-called gold clauses in contracts formed after 1977.[8]
Yes. I didn’t mean to say anything about their current legal status—my point was just that if the government doesn’t want you to use something as a medium of exchange, they can make it extremely inconvenient.
Which governments force people to accept and use their currency?
The US government and most other Western governments, impose their currencies whenever there are transactions with the government. You typically have you pay your taxes in the national currency. Likewise, the government will pay its employees in the local currency, it will pay its debts in its currency, and when it exercises eminent domain, it can force you to take currency in exchange for property.
If you look at a dollar bill, it says “this note is legal tender for all debts, public and private.” As you note, you can contract to be paid in anything you like, but that only gets you so far. When there is a debt, the debtor has the right to pay in dollars. This limits your ability to opt out of the national currency. If you go to court in the US to enforce a contract, the court won’t typically require “specific performance”—instead, the court will impose money damages, which are a debt, payable in dollars. You can agree to pay the plumber in silver, but if you don’t, the plumber will have to accept dollars.
There is some rationale for currency backed by hard commodities. Most people nowadays consider that the drawbacks outweigh the advantages, but valid arguments pro exist.
Was there a rationale historically?
Yes. The governments have a habit of printing money and it’s an addictive thing. You need ways to stop the governments from going on a binge and printing lots and lots of money (historically, that happened on a pretty regular basis). Nowadays in the West the problem is considered fixed because technically governments don’t print money any more, it’s done by a theoretically independent central bank which does not have to listen to what the government tells it. In practice it’s… slightly different :-/
Dollars already have value. You need to give them to the US government in order to produce valuable goods and services inside the United States. That’s all there is to it, really—if someone wants to make #{product} in a US plant, they now owe US dollars to the government, which they need to acquire by selling #{product}. So if you have US dollars, you can buy things like #{product}.
All money is fiat money, regardless of what material you use. If you use printed paper, it’s fiat money. If you use precious metals, it’s fiat money. It makes no difference because no metal (or any material) has “intrinsic” value. There is no such thing as “intrinsic” value because value is an opinion, not a fact. Money is not a fact; money is a symbol.
It makes no difference because no metal (or any material) has “intrinsic” value. There is no such thing as “intrinsic” value because value is an opinion, not a fact.
You are misunderstanding the term.
Something with intrinsic value is generally useful even if you strip it of its symbolic value. A sheep can be used as a money unit, but even if people stop using sheep as money the sheep is still useful—you can shear its wool, milk it, or just eat it. A banknote, on the other hand, is quite useless if it loses the ability to be exchanged for other things of value.
It’s still paper, though. Post-WWI Germans used devalued Mark notes as wallpaper and fuel. Those notes might have had other uses to beings with other preferences. In your example, the sheep is only valuable to beings who like/want to wear wool and can digest animal protein. That’s why value is never intrinsic. There’s no case where the value is a property of the thing itself; it depends on whom you ask.
The words “intrinsic value” when applied to money have a well-known and sufficiently defined meaning. You are welcome to insist that the term is wrong, but I don’t see much point if you want to talk to other people.
I understand what you are saying and you are correct that value is not a property of a “thing itself”, it’s just that this observation is irrelevant in the context.
Money is backed by violence. If you take some that isn’t yours then violence is done to you. Unless you take a whole bunch of it, in which case you get to use violence instead of experience it. The lack of a nation (with its police and military) to back a currency means it is valuable until it isn’t. With a nation and the violence that defines a nation, money is worth what the nation says it is no matter what we think or prefer. The state
monopoly on money is enforced by the state monopoly on violence.
1) The rationale is that silver is significantly harder to create, while paper notes are easy. If the paper notes must be redeemable for silver, it is some level of control on the creation of paper notes, in that a rational economic actor is unlikely to create significantly more notes than they can redeem. Austrian Business Cycle Theory places the blame for the business cycles firmly on the creation of unbacked paper currencies and the resulting inflation. Most people calling for sliver (or gold for that matter) backing of the US dollar subscribe to ABCT, and believe that such backing would reduce or eliminate the damage done by business cycles.
Thanks, I think I follow this explanation to some degree.
Here is what I still don’t get: What is special about the silver? Instead of limiting the money supply by linking it to silver, why not just choose an arbitrary number of dollars and say, “that’s the limit?” It seems to me that the quantity of silver is limited and arbitrary, so I still don’t understand what the advantage would be for using silver backing.
Because it’s easy to change your mind.
Don’t know how to link to comments; could you read my comment above to asr?
The second-last icon on the bottom right of a corner is a permalink; right-click on it and select “Copy Link Location” or whatever your browser’s equivalent is, then paste it where needed.
Can’t we look into precommitment mechanisms (I am skeptical of the current batch of crypto$, but crypto seems like a good field to look into for precommitments).
Yes, it’s arbitrary. On the other hand, governments historically have a mixed track record at keeping their word when they promise not to wreck the currency. It’s easy and tempting to cheat if there isn’t some physical limit to expanding the money supply.
I understand and agree with what you and Lumifer (below) say about how it’s easy to “cheat” if you don’t have a physical limitation on the money supply.
However, wouldn’t it be just as easy to change your mind with the physical backing: “Now you pay two dollars to get an ounce of gold, whereas in the past you paid one dollar per ounce of gold.”?
I guess to get to the crux of the matter—does the fact that there is a physical/concrete/non-abstract component involved sufficiently blind people to the fact that inflation could still happen under this system that it once proved effective for preventing mass loss of confidence?
Governments can indeed do this—the usual term is “devaluing.” But a devaluation is a blatant obvious politically costly thing, in a way that letting inflation gradually creep up from 2% to 4% to 8% isn’t. So it’s not “just as easy.”
Actually, the usual term is debasement of currency :-) Devaluing refers to changing the foreign exchange rate.
No. There isn’t. There are many bad rationales for metal-backed currencies, but as a practical matter given the relative sizes of modern economies and the sizes of precious metal reserves, any such setup would have to be absurdly leveraged
Meaning that there would be very little actual metal backing the theoretical convertibility, so it would be vulnerable as all hell to runs. The smallest twitch of panic in the markets would utterly exhaust the actual reserves, so the backing would be a lie.
Or alternatively the price on the precious metals would have to be so absurdly high that the distinction between a mine and a printing press would be utterly meaningless.
Very rough numbers pulled from wikipedia: in order for the value of silver reserves to equal gdp the price of silver would need to hit.. (90 trillion gross world product /540,000 tonnes of silver) .. about 5000 dollars/troy ounce at which point the currency can be debased by mining more silver because the price of doing so would be 2 orders of magnitude less than the value of the metal. And this would in fact instantly start happening unless you outlaw silver mining. Effectively that would be legal currency printing for anyone with a silver mine. Hello inflation.
1) Distinguish between government and individual use of value-tokens. For individuals, money can be traded for silver at many shops, and silver for money at some of them. Of course, there are probably better stores of value than either USD or shiny metal (I might suggest productive working capital in the form of equipment, education, stocks/bonds, or other investments).
2) Anyone who uses the phrase “intrinsic value” is at least 50 years out of date in their microecon thinking—http://en.wikipedia.org/wiki/Marginalism is a good intro to a more modern (and in fact more true—it fits actual data a lot better) theory.
Yes, there is a rationale for having a commodity-backed currency.
Fiat currency has a failure mode in which there’s a self-reinforcing mutual lack of confidence. If I think that the Ruritanian Lira is wastepaper, I will try to get rid of my Lira—I will spend as fast as possible. And this is inflationary. And once other people see the inflationary pressure, they also will head for the exits. Purely fiat currencies can go effectively to zero within a period of a few years—particularly if they are backed by a weak government that isn’t reliably able to force people to accept and use the currency.
With metal or other commodity currencies, there’s a floor on that process. Whatever you think of the Ruritanian government, you can use silver for jewelry, wiring, and so forth. Silver does have an intrinsic value separate from its use as a currency. Put another way—if the currency depreciated badly enough, people would limit the money supply by melting down the silver and using it for wiring, and that would limit the inflationary pressure.
That doesn’t necessarily make silver currency a good idea or even a good investment—it might happen that the market-clearing price, if you ignore the currency uses, leaves a lot of room for depreciation.
I think that you’re kind of getting at my thinking: the fact the silver has other uses might be a psychological stabilizer, to prevent or slow the self-reinforcing mutual lack of confidence.
This is (I think) what I’m trying to tease apart—that the economy might benefit from this comfort people feel, but in a more “rational” evaluation, the silver backing isn’t necessary.
Which governments force people to accept and use their currency? If I hire a plumber to clear my drains, I can legally pay him with whatever we can both agree on. If I have something to sell, no law obliges me to state a price or accept offers in money. Money is just the most convenient way to do these transactions. My country uses pounds, but there is no law stopping me from opening a bank account denominated in dollars, and shops in London often accept euros. The Truck Acts are the closest thing to a requirement on anyone to use money, but were enacted for the protection of workers, not the support of the currency .
Someone linked to this article, which links to this article describing how bottles of Tide detergent are being used as money. The people involved are committing many offences, but using Tide as money is not one of them. It is also clear from the latter link that the claim in the former that “all currency is fiat currency” is wrong. Tide is not fiat currency. It only gets to be used as a medium of exchange because it is valued as detergent. The subjectivity of value has nothing to do with the concept of fiat currency.
All of them. Try paying your taxes in anything else other than pounds.
All governments force people to use their currency for certain transactions, but most allow the use of other currencies (or other methods for settling transactions) as well.
What else would I use anyway? Tobacco? Farm produce? Old Master paintings? Oh, actually, all of those have been used at various times and places.
If taxation is all you can find to support the idea of governments forcing their fiat money on the people, it’s not much of a case.
I don’t see any need for a case. Looking at the world empirically, I see governments everywhere having a lot of success in “forcing their fiat money on the people”. Even in the third world where not infrequently there is a parallel currency (like USD or EUR) in circulation, the local currency is still being actively used. For one, the government pays in it so if you work for the state or you’re a business which sold something to the state, local currency is what you get.
You’re certainly right that some governments, some of the time, allow payment in-kind and don’t impose a currency. Most modern governments, however, do require you to pay your taxes in the national currency. Can you pay HMRC in anything other than UK pounds?
By the way, it’s not quite true that ” If I hire a plumber to clear my drains, I can legally pay him with whatever we can both agree on.”
If you agree to pay in cocaine, no US court will enforce the contract—it is void as against public policy. Likewise, starting in 1934, the US government declared Gold clauses in contracts unenforceable.
(Edit: As gwern notes below, this was repealed about 40 years later; my point was that the government can de facto stop you from using Gold or Silver as a medium of exchange, if they so wish)
https://en.wikipedia.org/wiki/Gold_Reserve_Act
https://en.wikipedia.org/wiki/Gold_Clause_Cases
Yes. I didn’t mean to say anything about their current legal status—my point was just that if the government doesn’t want you to use something as a medium of exchange, they can make it extremely inconvenient.
In an amusing bit of synchronicity, it seems that Satoshi Nakamoto picked a fake birthdate for his P2P Foundation profile which references both the original executive orders banning gold and the relegalization: http://www.reddit.com/r/Bitcoin/comments/229qvr/happy_birthday_satoshi_nakamoto/
The US government and most other Western governments, impose their currencies whenever there are transactions with the government. You typically have you pay your taxes in the national currency. Likewise, the government will pay its employees in the local currency, it will pay its debts in its currency, and when it exercises eminent domain, it can force you to take currency in exchange for property.
If you look at a dollar bill, it says “this note is legal tender for all debts, public and private.” As you note, you can contract to be paid in anything you like, but that only gets you so far. When there is a debt, the debtor has the right to pay in dollars. This limits your ability to opt out of the national currency. If you go to court in the US to enforce a contract, the court won’t typically require “specific performance”—instead, the court will impose money damages, which are a debt, payable in dollars. You can agree to pay the plumber in silver, but if you don’t, the plumber will have to accept dollars.
There is some rationale for currency backed by hard commodities. Most people nowadays consider that the drawbacks outweigh the advantages, but valid arguments pro exist.
Yes. The governments have a habit of printing money and it’s an addictive thing. You need ways to stop the governments from going on a binge and printing lots and lots of money (historically, that happened on a pretty regular basis). Nowadays in the West the problem is considered fixed because technically governments don’t print money any more, it’s done by a theoretically independent central bank which does not have to listen to what the government tells it. In practice it’s… slightly different :-/
I think limiting the printing of money may have been useful before central banking, so I think that’s a good point.
Serious question : why not drop by your friendly neighborhood University and ask (or email) an economist?
Dollars already have value. You need to give them to the US government in order to produce valuable goods and services inside the United States. That’s all there is to it, really—if someone wants to make #{product} in a US plant, they now owe US dollars to the government, which they need to acquire by selling #{product}. So if you have US dollars, you can buy things like #{product}.
That’s the concise answer.
All money is fiat money, regardless of what material you use. If you use printed paper, it’s fiat money. If you use precious metals, it’s fiat money. It makes no difference because no metal (or any material) has “intrinsic” value. There is no such thing as “intrinsic” value because value is an opinion, not a fact. Money is not a fact; money is a symbol.
More details at:
http://www.forbes.com/sites/pascalemmanuelgobry/2013/01/08/all-money-is-fiat-money/
http://www.alternet.org/story/146150/have_you_caught_gold_fever_the_value_of_that_shiny_metal_is_as_artificial_as_paper_money?paging=off¤t_page=1
You are misunderstanding the term.
Something with intrinsic value is generally useful even if you strip it of its symbolic value. A sheep can be used as a money unit, but even if people stop using sheep as money the sheep is still useful—you can shear its wool, milk it, or just eat it. A banknote, on the other hand, is quite useless if it loses the ability to be exchanged for other things of value.
It’s still paper, though. Post-WWI Germans used devalued Mark notes as wallpaper and fuel. Those notes might have had other uses to beings with other preferences. In your example, the sheep is only valuable to beings who like/want to wear wool and can digest animal protein. That’s why value is never intrinsic. There’s no case where the value is a property of the thing itself; it depends on whom you ask.
The words “intrinsic value” when applied to money have a well-known and sufficiently defined meaning. You are welcome to insist that the term is wrong, but I don’t see much point if you want to talk to other people.
I understand what you are saying and you are correct that value is not a property of a “thing itself”, it’s just that this observation is irrelevant in the context.
Can you explain or link to more info about:
Wikipedia: “Intrinsic value (numismatics)”
See also use value and exchange value.
Money is backed by violence. If you take some that isn’t yours then violence is done to you. Unless you take a whole bunch of it, in which case you get to use violence instead of experience it. The lack of a nation (with its police and military) to back a currency means it is valuable until it isn’t. With a nation and the violence that defines a nation, money is worth what the nation says it is no matter what we think or prefer. The state monopoly on money is enforced by the state monopoly on violence.