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Thursday, 14 July 2011

Fiat money has real value

Fiat money has real value


The actual material our money is made of today has, for practical purposes, no intrinsic value in itself. Our monetary unit is fiat money that is created by government fiat or decree. The government declares fiat money to be legal tender. In the past monetary coins were made of, for example, silver or gold which were valuable in themselves. The actual metal of which the coin was made had a real or intrinsic value supposedly equivalent to the nominal value inscribed on the coin. Today fiat money is a government decreed and legally recognized unstable medium of exchange, unstable unit of account and unstable store of value in the economy.

The actual material today´s fiat money is made of has no intrinsic value as fiat money is the natural product of the development of the concept of money through time. In the beginning a monetary unit was a (supposedly) full value metal coin. Later it was not a full value metal coin but it was the next best thing as far as economic agents were concerned: it was 100 per cent backed by gold. Today the material fiat money is made of has no intrinsic value and the monetary unit is not backed by gold but is backed by the combined macroeconomic real value of all the underlying value systems in a particular economy or monetary union. These underlying value systems include, but, are not limited to sound governance, a sound economic system, a sound manufacturing system, a sound industrial system, a sound monetary system, a sound political system, a sound social system, a sound educational system, a sound defence system, a sound health system, a sound security system, a sound legal system, a sound accounting system and so on, to name but a few.

Changes in the real value of unstable money – which is also the unstable accounting monetary unit of account – are determined by inflation and deflation over time. The real value of money and thus the monetary unit of account are not stable. The real value of money and other monetary items are currently not updated or inflation-adjusted over time in ledger and bank accounts.

Fortunately, (1) the generally accepted accounting principle of financial capital maintenance in units of constant purchasing power, (2) double entry accounting, (3) the fact that the constant real non-monetary value of capital is equal to the real value of net assets and (4) the fact that companies have unlimited lifetimes, make it possible to automatically maintain the real value of constant items constant forever in entities that at least break even – ceteris paribus – when they implement Constant Item Purchasing Power Accounting during low inflation and deflation as authorized in IFRS – whether they own any fixed assets or not.

The bank notes and coins that make up about 7% of the fiat money supply can almost be stated to be created out of nothing - out of thin air – as a result of the fact that the actual materials used to create physical bank notes and coins have – in principle – almost no intrinsic value. The unstable real value of the total fiat money supply is, however, backed by all – the sum total of – the underlying value systems in an economy, namely sound governance, sound economic policies, sound monetary policies, sound industrial policies, sound commercial policies, etc. Positive annual inflation indicates the excess of fiat money created in the banking system.

Fiat money is used every day by almost 7 billion people to buy anything and everything in the world economy. Fiat money has real value. All monetary units in the world are fiat money. Every person knows exactly what he or she can buy with 1 or 10 or 100 or 1000 units of fiat money in his or her economy – today. Many people also know that the real value of fiat money is eroded over time in an inflationary economy and increases over time in a deflationary economy.

Yes, the special bank paper that fiat bank notes is made of and the metals that fiat bank coins are made of have almost no intrinsic value as compared to the real value of the actual gold or actual silver in gold and silver coins of commodity money in the past. That is not a logical reason to state that fiat money has no value. Every fiat monetary unit´s real value is determined by what it can buy today in an average consumer basket of goods and services. That generally changes every month.

Fiat money is money which generally has a monthly changing real value. Only the actual bank notes and coins have insignificant intrinsic values. Bank notes and coins constitute only about 7% of the US money supply.

All fiat monetary units – whether notes and coins or simply electronically represented virtual values – are legal tender in their respective economies.

All fiat functional currencies within economies have international exchange rates with the fiat functional currencies of other economies.

The fact that fiat money is not legally convertible into gold on demand as it was done in the days of the gold standard, is made irrelevant by the indisputable fact that fiat money is legal tender. Fiat money is used to buy gold. The fact that fiat money is not legally convertible into gold – an administrative process – is true: it is a fact. That does not negate the fact that fiat money has real value, the change of which is indicated monthly in the change in the Consumer Price Index.

The fact that fiat money has real value is so mainstream – almost 7 billion people know it and confirm it daily – 365 days a year – by using fiat money to buy and sell everything in all economies. The fact that fiat money has real value is confirmed once a month by about all economies world–wide when monthly inflation indexes are published indicating the change in the real value of fiat money. It is thus misleading to imply that because it is a fact that fiat money cannot administratively be converted at the central bank or any other bank into gold, that fiat money has no value.

It is an indisputable mainstream fact that fiat money has real value despite the fact that it is not legally convertible into gold on demand and that the bank paper bank notes and metals bank coins are made of have no intrinsic value whereas historically gold and silver coins had intrinsic values equal to the real value of the gold and silver they were made of.

The numerous publications of CPI values world–wide are the creditable references to the fact that fiat money has real value. Statistics authorities are generally creditable sources.


Nicolaas Smith

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