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The Failure of Fiat

TL;DR: If you are concerned with inequality, the future of our environment, or the social decay in our cities, you cannot afford to be ignorant of our fiat monetary systems. It is the root cause of these problems and many more. Incentives rule all human behavior, and even subtle and small gradients in incentives can have a drastic impact on mass human behavior if those incentives are all-pervasive. The monetary system is the most pervasive system, and it influences us tremendously. Fortunately, there is a fix — but we must first understand the source of the problem.

The Failure of Fiat

A previous piece introduced money as technology, what functions that technology performs, and why we cannot simply dispose of it as well-meaning socialists would like. This piece is intended to discuss the currently implemented monetary system in order to elucidate the operation of our existing financial system, and how it creates the tipping point toward a bleak future for humanity.

The Failure of Fiat

Since 1971, Fiat money has become the predominant type of money used in the world. While there are other options, this has become dominant due to its technical superiority both to the users and to those in charge of maintaining the monetary system. However, fiat money is an imprecise term, and simply means money that has been given value by decree (fiat).

One option for a fiat system is for the state to simply print paper money, and decree that it must be accepted as payment for debts. This has two major problems. Firstly, regulating the supply of fiat when there is no “cost” associated with creating new money is very complex and can easily go into hyperinflation.

Shell Game

The second problem is, how is new money distributed?  One possible mechanism is for the government to print new money and use it to pay its employees in addition to taxes. Unfortunately, keeping the government budget to a size that the economy can support without hyperinflation is nigh impossible.

The Failure of Fiat

The system most nations use today is referred to as a “central banking system.” In this system, the national currency is issued by a central bank which is partnered directly with the government. This central bank is owned by private interests which have an incentive to create a stable currency by keep inflation under control. This bank then loans new money out at a set interest rate.

Loaning money out may initially seem more fair, as you must “pay it back with interest.” However, this is mostly a shell-game. First, and most importantly you should immediately wonder, “If all the currency is issued by the central bank, and they are charging interest, how can anyone pay back the loan?”  Secondly, who can get loans for money and how are these loans secured?

We Borrow From Our Future

The answer to the first question is that if you are unable to make a profit on your loan from someone else who took a loan, then you will be forced to take another loan from the central bank in order to pay off the first. The only way this mathematically functions is if interests rates are continually reduced. We borrow from our future in order to spur present-day activity, at the expense of future activity. In fact, economists talk about “stimulating the economy” as though it won’t function without being artificially “stimulated.”

The Failure of Fiat

The second question is that there are a set of banks which own the central bank, these banks are allowed to borrow money, and are required to hold some percentage of funds on reserve with the bank. In return, they receive a preferred interest rate, and they make a profit by re-loaning this money to consumers at a higher rate. The profit that the Federal Reserve, less expenses, collects on its loans are then given to the government. These banks, and their owners, hold a particularly privileged position in society that is a government-granted special status.

Many sources which discuss the Federal Reserve talk about how it has tools to reduce inflation by increasing interest rates. However, raising these rates, as pointed out before lead to defaults on loans and economic depression as a mathematical necessity. Due to this “fair system” of loaning out money, the system ends up unstable by design and only exists precariously.

Incentives Drive All Decision Making

Most importantly, every dollar in circulation has more than one dollar in debt behind it — or said another way, every dollar in circulation generates a short position of greater magnitude. Again, for every dollar in circulation, there is someone else holding a short position on that dollar. Those individuals are incentivized to devalue the dollar, increasing inflation.

The Failure of Fiat

Now, incentives drive all decision making. Even subtle imbalances in incentives at scale can have massive consequences on human behavior, and the economy. The fact that money in a fiat system is always going to be worth less tomorrow than it is today means that everyone is incentivized to spend their money now, and to take on debt. In fact, this is what economists mean when they say they’re “stimulating the economy.” They are encouraging everyone to spend more than they otherwise would.

Put another way, this stimulus shortens our time preference drastically. Our behavior is shifted to short-sighted pursuits, to consumerism, unnecessary consumption, a lack of concern for own long term future, and disincentivizes corporations and people in planning for our collective future. We burn coal we otherwise wouldn’t, we mine for resources we don’t need, we buy plastic junk we don’t really want. We generate mountains of plastic garbage we wouldn’t if we were thinking clearly, without the influence of these economic stimulants.

Structural Inequality

If you believe in structural inequality, that the there are real global environmental concerns, that everyone should have their material need met, that their should be medical needs met, then the most efficacious action you could take would be to stop using debt-based currencies immediately. Pay off your debt, move your money into tangible assets, and use cryptocurrencies for commerce.  

Some people claim cryptocurrencies are wasteful. But, think about all the waste generated by our short-term insane thinking created by the incentives of debt. Cryptocurrencies are free of debt, and the net impact they have on our society is far, far less than anything that debt-based currencies cause.

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