Let’s begin with a comment anarcholibertarian made about my article Four Valuable Lessons From Actually reading the Regression Theorem.

Our buddy David Kramer made a comment about this article which I am also wondering about. He says:

“’4. Fiat money has a yesterday, and thus does not violate the regression theorem.’

If by ‘fiat’ he means the paper FRNs [= Federal reserve Notes] which forcefully/fraudulently replaced U.S. Gold and Silver certificates (which, in and of themselves, REPRESENTED something of value and were not the valued commodity itself), he’s wrong.”

Could it be that government force is the only reason why the dollar is in general use? What would happen if the government told everyone to use a random token or they will be shot? I’m thinking that it will be volatile in price, since no one knows how much 1 token is worth compared to 100 tokens, but it would still be in general use out of fear. I’m still reading through your bitcoin articles, so if you have already answered this, just point me in the right direction if you please.

Good stuff. Here’s my reply:

It’s only lately that I’ve come to understand some deep stuff about fiat money. So here is what I know.

A. Kramer’s argument is not with me, but with Mises, whom I quote extensively in the beginning of the article. A slow careful reading shows that Mises is talking exactly about FRN’s when he writes:

The other possible case is that in which coins that once circulated as commodity money are transformed into fiat money by cessation of free coinage (either because there was no further minting at all or because minting was continued only on behalf of the Treasury), no obligation of conversion being de jure or de facto assumed by anybody, and nobody having any grounds for hoping that such an obligation ever would be assumed by anybody. Here the starting point for the valuation lies in the objective exchange value of the coins at the time of the cessation of free coinage.

The situation he describes is that of a country whose money is coins. One day, the govt says it will no longer make any coins, only fiat [=intrinsically worthless] money, not redeemable for anything. And he goes on to say that the reg. thm is satisfied.

That’s my appeal to authority. And the logic behind it is impeccable, as well. What’s the basic question the reg thm asks? In a word, it’s “How does a person know the purchasing power of this new money?” How does he know how many apples the grocer will give him, how many books amazon.com will give him, etc etc etc?
Mises has a simple answer. For commodity money, he knows he will get at least its value as a commodity, the commodity price. For a newly introduced fiat money, he assumes it will get him the same stuff that the old commodity money of the same name used to buy. A silver dollar bought me a gallon of gas? Then this new paper dollar will probably get me the same thing. A dollar is a dollar. I imagine that historically, this has been the case as well.

In short, the reg thm asks, “What number?” and for fiat money, even FRNs, we have an answer. Same number as the old money.

B. This is what I knew at first. Then I found Mises writing in Money and Credit that when a govt in the old days tried to debase the coinage by making the coins only partially gold, their purchasing power instantly dropped to be worth only the amount of gold they actually still contained. Which led me to ask myself, “Isn’t going from a silver dollar to a paper dollar the ultimate debasing of the coin? I mean, instead of making only 90% silver, the way the kings in the old days debased the coinage, they are making a new “coin” with zero percent silver.”

How does that not contradict what Mises wrote in Money and Credit, the very same book, about fiat money being just fine and satisfying the reg. thm?

My answer is that yes, fiat money satisfies the theoretical problem posed by the regression theorem, for the reason above, but it has another, different, more serious problem. People will drop it like a hot potato as soon as they get a chance. “Yes, there is a number that can be assigned to it, but who wants this garbage, if I have a choice?” I wrote about this at length, quoting Mises and explaining his arguments, in my humble article, The Kickstart Fallacy.

Maybe Kramer had this other problem in mind when he said I was wrong about FRNs.

C. So why is fiat money accepted at all? I think the only possible answer is because of some kind of violence, or threat of violence. Why did that not work for the old kings, but did work for FDR and for all modern countries today?

I’m not sure. Here are some guesses.

Peter Schiff says that modern fiat currency has a twisted kind of “intrinsic value” [= value besides trading it for goods and services], in that you need some of it on hand to pay your taxes. Maybe in the old days you could still pay in geese and chickens if you had no cash, and that’s why the old kings failed.

Maybe in the old days there were no legal tender laws. In the Kickstart Fallacy article I appealed to Thier’s Law at one point, which distinguishes between a country with legal tender laws and one without.

Both those theories will need a lot of historical research to see if they are consistent with the facts, research I am totally unfit to do.

A final guess is that maybe it takes some time, maybe depending on the size of the country or some other factor, for the debasement to take place. In other words, we know the dollar and all fiat currencies are constantly losing value. Usually this is attributed to inflation of the money supply, and of course that is correct. But maybe there is another force at work, that exists even with a constant money supply, mainly the Law of Debasement, we may call it, that says money will eventually sink to the purchasing power it has as a commodity.

D. For the repercussions of all this to bitcoin, I refer you to the Kickstart Fallacy article.

For most of my stuff on bitcoin, see http://smilingdavesblog.wordpress.com/2012/08/03/bitcoin-all-in-one-place/

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