Fiat Authenticity or Fake Authenticity?
If we were to narrate the root of all global financial and economic crises from World War II to the present in one phrase, we could only say: fiat money of the world’s governments! There are numerous debates and arguments about this. But we must be honest: the current monetary system might have been the best solution available at the time. However, today, swearing by the authenticity of state-controlled currencies seems futile, especially when digital currencies have fully revealed their benefits and power. What will be discussed in this article concerns the topic of “Fiat Authenticity.”
Table of Contents
Introduction
If we go back to the middle of 2006, some of the best financial market specialists who handled large accounts and transactions could sense an impending financial and economic crisis. Many skeptically and with mixed surprise viewed this pessimism and dismissed it. 2007 arrived, and liquidity and housing markets showed signs of crisis. Once again, people, the Bush administration (George W. Bush), and numerous large financial and economic entities did not take the threat seriously. Perhaps they were right, as it was the beginning of presidential election campaigns. 2008 came, and everything—ranging from the credibility and reputation of the Republicans to the housing industry and large manufacturing companies—was swept away by a devastating flood!
Undoubtedly, the 2008 crisis had started long before, but many believe that the “housing bubble” was the final link in the chain of its causes. But let’s be honest and brave enough to ask: when do bubbles emerge in an economy? The simple answer is this: when an immense amount of money is injected somewhere without regulation, and worse when money or quasi-money is created through unproductive or inefficient activities without real liquidity backing it up.
Let’s be a little braver: do governments, who are responsible for issuing, distributing, and managing fiat currencies, make foolish mistakes by following monetary policies that create bubbles? The one-word answer is no. Governments have incentives such as stimulating economic flows and even providing profit and rent to certain groups within society. Creating rent can lead to problems, but it is not inherently destructive. It is the ceiling and regulation that will determine its impact. For example, the political system in South Korea is a good example of this principle.
South Korea’s military and closed political system created a massive rent for domestic producers until the final decades of the 20th century, imposing almost a complete ban on importing foreign goods. However, the conditions for benefiting from this rent were the exportation of goods and the importation of new technologies into the country. The government did not have any friendship or brotherhood with any of the rent-seeking beneficiaries. If the conditions were violated, they were excluded from benefiting from the rent. Ultimately, the government of South Korea, with the empowerment of these rent-seeking institutions, faced no issue as long as currency and technology flowed into the country.
The government was wise enough to understand that with sufficient economic power and technology, they, too, would benefit. Rent-seekers needed the government to be powerful and exert more freedom, so they gradually spent their power to transition toward democracy. The result was the rise of powerful companies like Samsung, which dominated global technology and kept the military content, as it is one of the world’s largest producers of weapons and advanced military technologies.
So where exactly is the problem? In response, we would like to make a bold claim: effective management of money by governments is nearly impossible because fiat currencies lack physical backing! This might surprise you, but stay with us through the article and let us explore this claim.
Request: In this article, we aim to demonstrate the lack of authenticity in fiat currencies. To do so, we must explain some basic concepts about unbacked money and money creation. While doing so could turn this article into a book, we will briefly touch on these basics. However, we kindly ask readers to refer to the first half of two previous articles: “Dollarization: From Reality to Iran’s Strange Conditions” and “The Secrets of Money Creation: Printing Money by the Banking System at the Cost of Citizens,” which explain the basics in more detail and in simpler terms.
The Evolution of Money
Here, we do not intend to provide a complete history of money but rather introduce a concise definition for the purposes of this article. Nonetheless, referring to some issues will be beneficial.
To begin, if we summarize economics into three key sentences, we arrive at:
- “Nothing is free.”
- “Anything that can have value will always be scarce.”
- “Resources for meeting needs are limited, while needs are limitless. A way must be found to balance this imbalance.”
Money was created based on these three principles. Initially, needs were met through barter, with goods and services exchanged directly. The problem with barter was that it was not possible to accurately determine the real value of a good or service at any given moment. For instance, during a war, someone with medical skills becomes highly sought after, and wheat and iron become the most desirable goods, while someone who makes decorative items is forgotten and has no customers.
Therefore, people needed a “medium” whose value was universally understood and which everyone—better yet, society as a whole—could use to assess the value of their needs and possessions. Soon, precious and “scarce” metals like gold and silver became the standard for exchange, and based on collective understanding and mindset, goods were valued in relation to these metals. As a result, governments minted coins from these metals, with specified weight and purity, which for many years served as the medium of exchange and value calculation.
However, this system came with its own set of problems. For example, traders may have had 100 camels to buy and sell goods, but transporting enough gold and silver coins required an additional 10 camels. The risks involved, like highway robbery, counterfeit coins, and the standardization of coinage, as well as the heavy transportation costs, were major hurdles.
This is when certain individuals in countries were tasked with collecting large amounts of gold and silver in their treasuries, and traders used receipts and documents from these treasuries (or, more accurately, from the money changers) instead of carrying gold and silver themselves. These receipts were then exchanged for the corresponding amount of gold or silver in the destination city (a famous example for us Iranians would be the late “Mohammad Hossein Amin al-Zarb” and his son).
Money changers who collaborated would settle their accounts at specific times. These receipts were initially issued in the name of individuals but gradually became transferable and nameless, effectively giving birth to paper money. Each note represented a certain amount of gold or silver, and this method remained in place for a long time, with banks and governments assuming responsibility for issuing paper money.
As governments modernized, power became more centralized within the state, as it was necessary for a strong authority to resolve issues with different forms of money, receipts, and accounting methods, ultimately creating a unified currency with universal standards. Without going into details, this was when banks (whether central, private, or state-owned) and financial institutions realized they could “create money” without necessarily having sufficient gold or silver. Money changers had been doing this by issuing receipts beyond their actual gold and silver reserves. If they went bankrupt or were caught, they became discredited and faced severe consequences.
The key point is that the actions of banks and governments are rational, as economics has shown that in order to create wealth, money must be created to allow for investment and production, with individuals spending that money to buy goods and services. This means that individuals with the motivation and ability to create wealth need access to sufficient liquidity, and the general public must be able to purchase goods with it. If the production, supply, and demand cycles proceed smoothly and “without interference,” it results in general wealth growth.
However, the other side of the matter is that banks and governments did not need to worry about meeting the same fate as money changers because the additional money that was created, if it generated enough jobs, work, valuable construction, and production projects, and increased the reserve of precious metals or the ability to purchase them across society, was beneficial. If it failed to do so, inflation would result, taking from the pockets of every citizen. The notion that money creation can lead to inflation has been demonstrated by renowned economists.
Nevertheless, when each monetary unit was backed by a specific amount of gold or silver, there was a possibility of a “restart” if the system faltered and paper money lost its value. Through borrowing from other countries, purchasing precious metals, eliminating zeros from the currency, “redefining the monetary system,” reducing public expenditures, and enduring several years of economic austerity, it was possible to restore equilibrium between precious metals and the monetary units. Of course, during this process, both small and large stakeholders and government officials bore significant costs, but their situation was still naturally better than that of the old money changers.
However, for several reasons, this state of affairs was not sustainable. Consider the following two reasons:
First, it is exceedingly difficult to ensure sufficient gold or silver reserves to match the amount of money in circulation and maintain equilibrium. The global supply of gold and silver does not grow in proportion to the population and needs. Additionally, storing these metals incurs high maintenance costs and, by itself, does not create a cycle of investment and wealth generation. Moreover, the process of increasing liquidity and creating effective and beneficial money is very slow and requires navigating numerous economic, administrative, and policy-related complexities. If economic stagnation occurs for any reason, governments are often incapable of swift action.
Second, in times of emergencies and crises, modern governments have the authority to take necessary measures. Emergencies, above all else, require money, and if such conditions persist, such as during a prolonged pandemic or years of war, adherence to the physical monetary standard becomes practically impossible.
The conditions outlined in the first reason led to repeated and widespread changes in monetary systems in various countries and even internationally after World War I and the economic crisis of the 1920s. During World War II and its aftermath, international agreements established the United States dollar as a global reserve currency. Reconstruction following the war placed significant financial and cost pressures on the United States and Europe. Ultimately, the added burden of the Vietnam War’s expenses led President Richard Nixon of the United States to permanently abandon the gold standard for the dollar. Subsequently, one after another, all countries decoupled their monetary units from mandatory equivalence with gold and silver.
At this point, world currencies ceased to be receipts for gold or silver. In fact, monetary units no longer even corresponded to the printed banknotes. They were created by the signature of the president or a single click on the central bank governor’s computer, and they were injected into the national economies as loans and credit.
If you ask an economist what this means, they will explain that the military and financial power of governments, the reserves of gold, precious metals, and even mines and energy resources of a country, along with its production capacity, wealth creation, and international influence, are equivalent to its monetary backing.
In reality, if the amount of money corresponds to a country’s capacity to produce and manage problems, its currency (relative to its domestic purchasing power) holds value and maintains a beneficial and balanced inflation rate that fosters further economic activities. At this point, we must pause and ask: under what conditions can fiat currencies truly be effective within their respective countries and play an influential role internationally?
The prerequisite for any answer is a high level of economic and political power, both internationally and domestically, for governments and financial and economic institutions. Beyond that, the answers may vary but can generally be categorized into two groups:
First, the government, particularly the central bank, must possess overwhelmingly dominant and comprehensive regulatory power over monetary policies and money creation, coupled with mechanisms for the destruction of money. However, this power must be controlled through public oversight by independent institutions and the media to prevent misuse by government officials. In simple terms, governments and central banks need to have restrained but entirely effective authority. Another important condition is that the central bank must act as an independent partner of the government, not merely as its accountant or contractor.
Second, in addition to state-issued currencies, the existence of private currencies and exchangeable money systems among local and international unions must be permitted. These systems would compete to create effective and harmless money, ensuring that no one could misuse the system. To guarantee this, people and institutions should have the right to abandon any currency at the slightest deviation. However, an important condition must also be considered: transparency and decentralization of competing currencies. Otherwise, centralized currencies could eventually fall under state regulatory control, functioning similarly to government money.
The first response was challenged years ago by the renowned Nobel Prize-winning economist Friedrich August von Hayek, who introduced the idea of “privatizing money.” Its inefficiency was well demonstrated. Hayek was fundamentally opposed to any form of deep state control. He argued that monetary sovereignty requires prerequisites and conditions that seem impossible within a state structure. We will also show why this is the case.
The second response, however, has gained clarity with the emergence of blockchain technology and cryptocurrencies. At this point, we will leave the examination of the second response for now.
Why Do Governments Lack Effective Control Over Their Fiat Currencies?
Milton Friedman, the renowned economist and Nobel laureate, along with another eminent economist, Anna Jacobson Schwartz, raised the question in their 1987 article “Does Government Have a Role in Money?” whether the market can manage money effectively without government intervention.
The authors review historical records and the emergence of a global monetary system dominated by fiat currencies, arguing that government intervention in money has often led to instability and inefficiency. While they acknowledge reasonable justifications for government involvement, they ultimately show that both theoretical evidence and historical reasons suggest that government intervention in money and monetary structures causes more harm than good. They argue that government intervention in money often leads to instability and inefficiency for several key reasons:
Weak Policy Decisions:
Government interventions often involve discretionary decisions that can lead to economic instability. For example, the creation of the Federal Reserve System intended as a reform, has, in practice, contributed to instability rather than reducing it.
Inflationary Pressures:
Government control, especially over monetary policies, has historically contributed to increased inflation. For instance, inflation in the U.S. during the 1960s and 1970s was exacerbated by government monetary policies, leading to economic instability.
Misallocation of Resources:
Government interventions can also lead to inefficiency by distorting market mechanisms. One example is the creation of mutual funds in the money market as a response to government-imposed interest rate controls. While these funds aimed to serve a purpose, they led to social waste by absorbing resources that could have been used more productively elsewhere.
Failure to Achieve Stability:
Despite the logic that government intervention is necessary to provide a stable monetary framework, historical evidence shows that such interventions have often failed to achieve this goal and instead led to greater instability and inefficiency.
What these prominent economists have explained is just a part of the evidence suggesting that government control over money is ineffective and, to some extent, harmful and unstable. Over time, other aspects also come to light. It is natural for the government to have effective oversight over the creation of money, ensuring that money is either created through government channels or closely monitored by the state via banks and economic entities, as long as necessary. Even if it causes harm to some segments of society, the central bank must restore balance by not redeeming government liabilities and/or by eliminating idle money through the bankruptcy of businesses and the loss of capital, thereby preventing inflation and other economic problems.
Thus, even if we assume that 100% of the decisions and actions taken by the government and central bank (at least in the short and medium terms) are inevitable and appropriate, we must ask whether their oversight is truly all-encompassing, leaving nothing unchecked? The percentage of money directly controlled by governments varies depending on the type of money and the existing economic system, and it can be divided into two broad categories:
- Central or Government-issued Money (Monetary Base)
- Broad Money Supply (including money created by commercial banks)
Monetary Base:
This includes circulating currency (cash) and reserves held by commercial banks at the central bank. Naturally, the central bank has complete control over this money.
Broader Money Supply:
The broader money supply includes the monetary base, plus other forms of money like savings accounts and other types of bank accounts. Commercial banks create most of this money when granting loans. In practice, the government has indirect control over this money and can only influence it through regulations or necessary licenses.
However, the government or central bank can influence it through monetary policies (such as setting interest rates or reserve requirements); still, the actual creation of this money largely lies in the hands of commercial banks. Estimates suggest that in many advanced economies, the central bank’s money accounts for only a small portion of the total money supply, typically around 5 to 15 percent. In other words, more than 85 percent of the money supply is created by private banks, which, even in highly regulated and effective economies with minimal government intervention, is not controlled by the government. Therefore, it could be said that regardless of the level of economic freedom, in the era of unbacked fiat currencies, the central bank or government control over the monetary sphere is essentially a joke!
Why Does Money Lack Intrinsic Value?
Money “lacks authenticity,” but we are not referring to the physical authenticity of currency. For example, to prevent counterfeiting, money includes authenticity features like watermarks, security threads, and holograms. However, when we discuss the notion that money has no intrinsic value or “authenticity” in a philosophical or economic sense, deeper issues about the nature of money emerge.
At first, the debate is about intrinsic value versus nominal value. Intrinsic value was only relevant for money when it consisted of coins made from precious metals like gold or silver or receipts representing a certain amount of these metals. However, most modern money, particularly fiat currencies, lacks intrinsic value. Its value comes from the trust and belief that people have in the issuing government and the economic system. This means that money is a social construct, a collective agreement on the value of paper notes or digital entries.
Thus, the “authenticity” of fiat money lies within the legal and institutional frameworks that support its use. With this backing, governments declare it legal tender, meaning it is accepted for transactions and debt payments, but it has no intrinsic value.
As mentioned, the value of money is based on trust and confidence. People accept it as a medium of exchange because they trust that others will do the same. If this trust breaks down (for example, due to severe inflation, political instability, or loss of confidence in the issuing authority), money can lose its value, revealing its lack of “intrinsic authenticity.”
Based on this, money is an abstract concept and a symbolic representation of value, not something that inherently possesses value. This is especially true in today’s digital economy, where much of the money exists as digital entries in databases, and any physical form of it has been eliminated.
Now, if we want to propose a solution, we must ask what options are available. Some suggest returning to backed currencies, while others advocate for digital money and cryptocurrencies. There are also those who discuss “governance of local currencies” within each country’s borders, which, frankly, is a delusion. Such arguments come from some “geniuses” who believe in the authenticity of money as well as borders! They also fail to understand that if it is possible to price labor based on local currencies due to a lack of dynamism and travel difficulties, it is impossible to determine the value of raw materials and technology, which are not entirely available within any country’s borders, using local fiat currencies. These can only be supplied through international “collaboration!”
There are dozens of other small and large solutions, but in practice, they don’t seem particularly serious.
Let’s use an example to illustrate why the return to a physical-backed money system is not feasible, and then we’ll take a look at private money.
An Example of Why Returning to the Gold Standard is Impossible
During the recent early elections, Alireza Zakani, the mayor of Tehran, who was also a presidential candidate, spoke about granting subsidies based on a gold-backed standard. At the time, both his supporters and opponents pointed out that the amount of gold required for each month would exceed the entire gold in circulation in Iran over the course of a year! Of course, these people did not realize that in the minds of the candidate’s advisers, this was actually a redefinition of the equivalence between gold and the subsidy unit! Moreover, what was being implied indirectly was that, regardless of the amount of gold, most of it would practically be inaccessible. In other words, the gold being discussed is just an illusion! It’s like announcing today that all esteemed readers have two kilograms of gold deposited with the writer, but they cannot withdraw it.
Let me give an example. Suppose, based on the total amount of extracted and unextracted gold reserves in the country, we want to define a new “Toman” currency. Estimates suggest there are 300 tons in the country’s mines, and the latest information from the central bank shows that about 100 tons of gold is in reserve. Suppose each gram of gold is worth one million new Tomans. That would mean the total money supply in the country is 400 trillion Tomans. The global price of gold is approximately $80 per gram, and the average price of meat is about $10 per kilogram. With this rough conversion, using this new Toman unit, the price of one kilogram of meat would be 125,000 Tomans.
Various statistics in our country (which can confuse anyone) suggest that each person consumes between 5 to 15 kilograms of red meat annually. Let’s assume it’s 10 kilograms per year per person. With a population of about 85 million, this means that 850,000 tons of meat are consumed annually, which requires about 106 trillion Tomans to cover! This means nearly a quarter of the new money supply would need to be allocated just for red meat consumption!
You might argue that this money will circulate and go to other sectors. The point is that all we need to do is create a basket of food and construction needs and then apply these rough calculations. Suddenly, we’ll realize that at least several dozen times the amount of money with backing would be needed to keep the economy running without leading to a liquidity shortage and “recession.” Simply put, the money supply is several times greater than the amount needed to cover something like red meat.
If we truly aim to create a monetary unit proportional to our economy, we would either need to have several hundred or even a thousand times the current amount of gold or periodically adjust the parity between the monetary unit and gold to align with our economy’s scale relative to the global economy. Alternatively, we could entirely reject global pricing and cross-border supply chains and instead price everything internally and completely by decree within this new monetary unit. Thus, a return to such a system is fundamentally no longer feasible!
Fiats are insubstantial units that derive value from public trust and the real productivity of the economy. But who says trust and value will last forever?
Private Money or Decentralized Money
Now that we have discussed the lack of intrinsic value in current currencies and the impossibility of returning to a concept of money backed by physical reserves, it’s worth mentioning Hayek’s proposal for privatizing money. He suggested that monetary control should be stripped from governments and instead issued by private institutions in a competitive market. Hayek argued that government monopolies on money lead to inflation, instability, and poor economic outcomes.
By allowing multiple private institutions to issue their own currencies, competition ensures that only stable and reliable forms of money survive, enhancing economic stability and reducing inflation risks. This idea challenges traditional views of monetary policy and the government’s role in managing national economies. Its core functionality lies in the principle that inefficient currencies would automatically be eliminated (assuming governments do not interfere and use public funds to cover losses).
Some individuals might suffer losses during such a transition, which is the nature of dynamic economic systems and markets. (An economy with sufficiently diverse investment, innovation, and production opportunities would open paths for many of these individuals.) However, it would not create dangerous inflation. Additionally, this issue is not without solutions. If these private currencies have calculable and reasonable risks, the insurance industry could cover those risks, offering at least some recourse for mitigating losses.
On the other hand, issuing money through private institutions can foster innovation in how currencies are managed, transferred, and utilized. This can lead to the development of more efficient payment systems and financial products. Individuals and businesses could choose the currency that best suits their needs, prioritizing stability, convenience, or other factors. This freedom of choice empowers both consumers and businesses alike.
However, potential drawbacks also exist. Perhaps the most significant issue is the difficulty of regulation and oversight. Governments might find it challenging to monitor multiple private currencies, which could lead to problems such as money laundering, tax evasion, or financial fraud.
Furthermore, having multiple competing currencies could cause confusion and inefficiency, particularly in transactions involving multiple currencies. The absence of a single, widely accepted currency could complicate trade, pricing, and accounting.
But do Hayek’s ideas align with the benefits of cryptocurrencies? Are the outlined disadvantages not addressed in the world of crypto-assets? A glance at articles in various issues of this journal or its website could provide insight. Essentially, by slightly modifying and generalizing Hayek’s ideas, and replacing centralized issuers with decentralized blockchain technologies, we can find answers.
The credibility of blockchain networks, like fiat currencies, stems from public trust coupled with the “participation” of all members and “transparency.” Contrary to popular belief, they are not entirely devoid of backing. Proof-of-work and proof-of-stake mechanisms, physical hardware infrastructures, the consensus among participants to expend energy for mining and transactions, the non-gratuitous nature of transactions, and the documents and assets gathered by the supporting foundations of crypto projects—all these constitute new forms of backing. These reserves are not centralized under governments but are distributed among all participants in a network! Such reserves cannot be exceeded to create more money, generate inflation, or encourage speculative behavior. In traditional monetary systems, governments can violate the fundamental elements of economic structures, like property rights, with or without formal legislation. However, in the logic of crypto-assets, this is utterly impossible.
It’s essential to note that this idea is not entirely new. Joint-stock companies and capital markets have used older versions of these blockchain tools to create value for themselves. The public consensus around the immaterial contract of a giant tech company like Apple, driven by trust in its innovation and efficiency, makes it valuable. Its value and existence are not tied to desks, buildings, or the number of employees. Unlike governments that can operate independently of consensus and still have money and generate inflation, inflation in the world of crypto-assets equals instant collapse!
There is much more to write, research, and explore on this topic, but this goes beyond the scope of the present article and may require a separate one to delve deeper.
Conclusion
Money has been a vital invention and tool for humanity to manage needs and scarcity. However, without physical backing, it is not only insubstantial but also prone to unintended consequences, affecting savings, production, and even societal well-being. Governments lack the capacity for adequate and proportional management, which is inherent to fiat systems. Furthermore, it’s hard to envision a solution to this issue other than introducing competition to fiat currencies. Today, however, crypto-assets provide an intriguing form of private money outside government monopolies, potentially paving the way for economic structures in the age of artificial intelligence and digital frameworks.
