The future of gold? Part 3: Why do people accept fiat-money?

After changing from gold standard to fiat money period, what is different? The main difference between under gold standard and fiat-money period is the inflation, even hyperinflation!!!

                                  Graph: Cumulative inflation in the US from 1913 to 2010

Source: inflationdata.com

In The theory of Monetary and Institutions, White (1999) pointed out that expected inflation during gold standard in the long run is zero. Under the fiat-money period, the inflation has risen dramatically. You can directly see in the above graph about the inflation rate in the US-the strongest economy in the world. From 1970s, after the ending of Bretton Woods system and marking for the using fiat money until now, the inflation rate looks like a staircase.Why do people accept fiat money? 

How do billionaires invest in gold?

To sum up the gold topic, you might wonder how do billionaires invest in gold now? Want to find out the answer, let's take a look to this video from youtube! Enjoy and get a plan for your money now.

Final part: The future of gold?

One painful fact that we need to be aware of is all the fiat money in history has collapsed. In the 19^th and 20^th centuries, some countries have faced with this problem. For example, the United State (1861-1865), Russia (1921-1922 and 1992-1999), Japan (1948-1951) and China (1948-1949) (Blogdial, 2012).

In 2012, the world economy has not been cured of the consequences from the 2008 economic crisis, yet. Now it is in danger of the sovereign debt in Europe. As Gordon Gekko (2010) mentioned that “economic crisis is in fact a currency crisis”. White, in an interview with abc news in 2011, stated “ European nations and Japan would also have to make the switch to make to system work better internationally".

Source http://goldnews.bullionvault.com/gold_central_banks_052420101

The price of gold has experienced a sharp increase in recent years. Beside the large demand gold for jewel, industries (health care, technology etc.), the demand of central banks is HUGE. We can see at the above graph of European central banks. Will gold come back to the monetary system as expected by some big guys like Robert Zoellick, the president of the World Bank. It is truly a big question. Edmund Conway (2011) warned us “No doubt gold is in a bubble, but all bubbles start with the germ of a good idea, which in this case is that the present system for running the world economy is close to breakage.” Recently, in May 2011, Utah state was the first in the US legally accept gold and silver coins while some other states are “expected to follow” Utah’s example (acb news, 2011). 

Theoretically, Dowd (1996) suggested discontinuing of precious metal. Instead the next monetary system generation could be based on “a basket of goods and services” which helps to “reduce the price-level instability” and people will happy to accept because it creates the price-level stability (White, L, 1999, p.23).

Dowd’s basket suggestion is such a good idea. In my opinion, however, by putting gold in that basket might create a better stability one. White (1999) claimed that, it may not be reliable when people concluded that “real income was less stable under the gold standard”. More importantly, history proved that gold makes people feel more confident in the banks (Khanacademic, 2011). In the period using bank issued money backed by gold, people did not directly use gold for exchanging. Gold was just stored in the banks’ vaults. But people simply believe in their banks. Last but not least, whether gold standard will comes back or not, the vital thing supports to the new monetary system is the international cooperation which helped classical gold standard was obeyed in many countries in the past.

The future of gold? Part 3: Why do people accept fiat-money?

After changing from gold standard to fiat money period, what is different? The main difference between under gold standard and fiat-money period is the inflation, even hyperinflation!!!

                                  Graph: Cumulative inflation in the US from 1913 to 2010

Source: http://inflationdata.com

In The theory of Monetary and Institutions, White (1999) pointed out that expected inflation during gold standard in the long run is zero. Under the fiat-money period, the inflation has risen dramatically. You can directly see in the above graph about the inflation rate in the US-the strongest economy in the world. From 1970s, after the ending of Bretton Woods system and marking for the using fiat money until now, the inflation rate looks like a staircase.Why do people accept fiat money? 

Some claimed that people accept fiat-money since it still has value when acting as the medium of exchange (Turner, J., 2012). David Glasner (2011) stated the backward induction idea of Earl Thompson to prove that fiat-money has no value. Imaging that we are at the end of fiat-money period, no seller will accept money in order to exchange their goods. Fiat-money, therefore, has no value. Glasner gave two theories to explain why people accept this worthless paper. First, people are not as rational as theory claimed they are. Second, according to Earl Thompson, fiat-money provides service actually. The government accepts fiat-money for paying discharge tax. It avoids the backward induction argument because the seller will accept fiat-money to pay tax latter.

Recently, Khanacademic (2011) stated that gold is not actual wealth while the fiat money give “the right to the authorities to tax” and support to the economy which is REAL WEALTH. Innovation products, new services, ideas etc. could be encouraged in the economy with fiat-money. Gold has a limited supply resource. How can a pure gold standard support to this dynamic economy? The fiat-money could be printed with flexiblity to support for the increasing wealth in the economy. So that people may agree to pay tax (inflation) to the government to have a better life. It means they believe in the ability of creating wealth by the governing of those politics. They believe that the governments do not print too many money than the amount is necessary to exchange in the economy. However, what if this belief goes down? The monetary system has been changed many times from gold-standard to fiat money and vice versa. What is the future of gold and will they back to the monetary system? Keep in touch with my blog for the next post.

The future of gold? Part 2: From gold standard to fiat-money

According to Menger theory, monies are goods which are “commonly accepted as medium exchange”. White (1999) pointed out that gold and silver overcome the other commodities, become widely accepted by people as money because they are saleable and have at least four special characteristics. First, they are uniform and easily recognized quality. Their uniform characteristics increase when they are in form of coinage. Second, gold and silvers are durable. They cannot be spoiled in long term. Moreover, they are easily divisible and fusible. Gold can be splited it into small prices or unite them from small pieces to larger one. Finally, gold and silver are portable. It means that they take a small of cost for transferring. Later, in the early form of bank-issued money, gold and silver still were the medium of redemption. The issued-money could be redeemed by the gold and silver reserved in the banks vaults.



Source: http://kwaves.com/fiat.htm

White (1999, p.14) clearly claimed that even different banks issued different types of money backed by gold, because of “profit motive” and “without legal compulsion” they still accepted different banks’ money at par value. So why did people change to the fiat money? Historically, the government monopolised the note issue to a central bank. Then, unable to pay their debt in gold or silver, they permanently suspended the central banks’ liabilities redemption, “central bank notes and deposits became a fiat base money” (White, L., 1999, p.19).

Why do people accept the money which cannot redeem anything? Perhaps, I would discuss this phenomenon in the next post ahead!

The future of gold? Part 1: Interested in gold?

On the following my professor about the free banking, I am really interested in the topic named "Free Banking and Gold". Basically, he gave directions for one of his followers to find the answer of himself question "whether a gold standard is essential for free banking". You could assess to those great ideas at the link: http://financelongrun.blogspot.com/2012/01/free-banking-and-gold.html

Actually, this post did remind me of one of my early research when I was a BSc student. As many finance students, I have been wondering why an incredible metal such as gold plays such an important role in the financial world and what is its future. For the time being, I would like to share with you my own research in the Gold subject.

Source: http://goldprice.org

The gold price has increased dramatically in recent years. Especially in 2011, the gold price continuously broke through its ceiling price and got new highest point at 1889.70 USD per ounce (World Gold Council, 2011, August). It leads to many questions. For instance, why a metal like gold can play an important role in today finance system and can it be the international currency in the future? In the next 3 following posts, I am going to discuss why gold acted as money in the gold-standard and why people changed to fiat-money (money without backed up by commodities). Then, I will take a look into the differences under gold standard and fiat money period. Finally, I am going to present the current gold demand and supply, point out some major situations in the world monetary system now to discuss the question the future of gold.