Here are some key factors affecting Fiat Money:
- Fiat currency is issued by governments and has no asset backing, such as gold.
- Fiat currency allows the central banks of governments to have more significant economic control because they are responsible for minting coin and printing notes that get into circulation.
- One of the significant problems with governments holding the strings is that they can initiate hyperinflation by printing more money than they can back up with capital assets.
What is Fiat Money?
Fiat currency is the tangible/visible/physical money, such as Euro, US Dollar, CAD (Canadian Dollar), issued by governments. It has no solid capitalisation such as gold or precious metals. Therefore, the fiat currency value is based on the supply and demand and the government’s stability and has no real physical asset value. Governments require banks to hold 10% of coin/currency as capital, and this means that the banks can lend or invest the remainder as they see fit.
How Fiat Money Works
Fiat currency value is maintained when a government or two parties within a financial transaction agree on the worth of the money.
Historically, the gold standard was used as the capital backing for the coin, and governments could only print new money when they had enough gold or silver in asset value to cover any paper or coin going into general circulation. This meant that paper money could be redeemed against the physical commodity value because fiat currency is inconvertible and therefore has no redeemable value.
The reason that currencies risk losing value due to inflation or at the very worst, hyperinflation, is because they have no physical reserve of gold or silver to back them. Gold continues to have high intrinsic value because it is used in the manufacture of jewellery, electronic devices, aerospace, and many other modern-day technological hardware.
The legal tender of a currency means that it is declared constitutional by a government and can be exchanged at the intrabank exchange rate to pay for goods and services. Most governments issue their fiat currency by setting it as the debt repayment standard, although its value fluctuates.
The gold standard ended in the United States in 1971. This was when the US government stopped exchanging US bullion to foreign governments in exchange for (buying back) US dollars. Since 1971, US dollars are backed by the “full faith and credit” of the US treasury and are considered legal tender for all private and public debts. However, US dollars are “not redeemable in lawful money at the US Treasury or at any Federal Reserve Bank” (as formerly stated on old US dollar bills).
Therefore, US dollar bills (paper currency and coin) are legal tender and have seigniorage.
Definition: [ref: https://www.dictionary.com/]
**Something claimed by a sovereign or superior as a prerogative.
**A charge on bullion brought to the mint to be coined.
**The difference between the cost of the bullion plus minting expenses and the value as money of the pieces coined, constituting a source of government revenue.
Pros and Cons of Fiat Currency
- Fiat currency has excellent seigniorage. If a country has strong governance, its money will hold value and take a robust fiduciary role in the country’s economy and world trading standards.
- Fiat currencies are traded internationally, and the central banks play the most significant role in the economies, quite often facilitating booms and busts through manipulation of supply and interest rates. For example, the US Federal Reserve mandate is to keep unemployment down and maintain a manageable level of inflation.
- In 2007 economic, financial meltdown, it was bank lending that brought about a mortgage crisis, and that didn’t end well. Not only the mortgage companies who lost a ton of money, but the commercial banking sector had to be bailed out by central banks to save the economy in every country in the world. This strengthened the belief that central banks had to take a firmer stand in regulating money supply and further reiterates the fact that a currency tied to gold, will be more stable due to the limited availability and supply of gold.
- One of the worst-case 21st-century scenarios was the super hyperinflation caused by the Zimbabwe government in response to their country’s economic woes. To keep the governing party in power to pay a bloated government payroll when the Reserve Bank of Zimbabwe printed money at an astoundingly industrial rate. By 2008, Zimbabwe had a 500 billion percent inflation level. At the height of the fiasco, 1 Trillion Zimbabwe Dollars was worth 40 US cents. The government had taken the country’s resources and squandered it without due heed of the consequences, further demonstrating that the general population has no control over their country’s fiduciary.
The author would like to point out that at the time of Zimbabwe independence in 1980, the government inherited a sound fiduciary and stable currency from the Rhodesian government, with a solid capitalisation in gold bullion.
- The printing and production not finite; the more currency in circulation, the less worth it has.
- The physical guarantee of fiat currency is based on the government in power and the country’s economy. The dangers arise when governments mismanage their country’s fiduciary, and the economy collapses, causing a knock-on effect of currency devaluation.
- There is no democracy surrounding fiat currency: Central Banks and Governments control the money, and citizens and users do not participate in the decisions.
- Banks can hold a minimum of 10% physical currency, and the remainder is held in capital investment, including lending and mortgages.
Fiat Currencies and the Banking System
The banking system needs you, but do you need them?
- The banking system charges transaction fees.
- The banking system aims to keep the most significant amount of money within the institution.
- The banking business is dependent on having enough user/customer capital to lend to investors.
- In case of a collapse of the banking system where the money circulates, the government uses taxpayer money to provide the bank with financial protection for account holders.
- The banks invest account holders’ money through credit lines granted to other customers, which stimulates economies through consumer spending.
What happens in a Currency Crisis?
Currency crises are primarily due to investor sentiment when expectations do not match what is going on economically within the country or region. History shows that when economic growth is too rapid, it creates instability and promotes a high level of capital flight and runs on fiat currency. No amount of central bank intervention helps when liquidity dries up.
A national currency crisis arises when there is a sharp fall in the value of fiat currency. The drop in currency value brings knock on negativity to trade and economy because it now costs more to run a business. Historically, financial crises have expounded in the forex market with a “pump-n-dump” by investors and traders, causing significant volatility and alarm, which compounds the negative value.
However, hyperinflation is more likely to be governmentally led through economic mismanagement. It is compounded by printing more money to try to plug the widening hole in government coffers.
Combatting a Currency Crisis
The first line of defense in economic, financial stability are Central Banks. The route taken by central banks in a fixed exchange rate administration will be either to “steal from Peter to pay Paul” by dipping into foreign reserves or promoting a floating rate in the Forex markets.
An increase in interest rates is often the precursor to devaluation. In this instance, the central bank shortens the money supply, which will create currency demand. The bank does this by selling off a portion of foreign reserves to create an outflow of capital. In return, they receive payment in the form of domestic fiat currency, which is kept out of circulation and held as an asset.
We should note that Central Banks are unable to bolster or support the exchange rate for a prolonged period due to several factors: drop in foreign reserves, rise in unemployment caused by political and economic elements. An increase in the fixed exchange rate, which will bring currency devaluation, does make imported goods more expensive, creating the need for cheaper domestic products, which should have a knock-on effect of boosting domestic output and job creation.
What Causes a Currency Crisis?
In the short term, the theoretical understanding by economists is that devaluation brings an increase in interest rates, offset by the central bank to prop up the fixed exchange by this devaluation, to boost the foreign reserves and thereby increase the supply of fiat currency. The downside of this scenario comes through investor intervention. When the market expects a currency devaluation, an increase in the exchange rate does not heighten the demand, and the result is that the Central Bank is forced to utilise reserves to shrink the financial resource, and this raises the national interest rate.
Currency Crisis Analysis
Capital flight is when investors rush to withdraw funds when they lack confidence in the stability of an economy. The exchange rate is further eroded by investors selling currency affiliated domestic investments by converting these investments to a foreign currency, causing a further exchange rate deterioration and bringing about a run on the money, which is virtually impossible to control. The government is unable to finance capital expenditure- they become bankrupt!
The predictions for currency crises are variable and are based on analysis that is diverse and complex, but there are some common factors in recent scenarios.
- Current Account Deficit (countries borrowed excessively from foreign investors)
- Sharp Increase in Currency Value
- Government fiduciary made investors skeptical
Examples of Currency Crises and how they Affected Investors
1994 – Latin America
December 20th, 1994 Mexican Peso – devalued
Backstory: from 1982, the Mexican economy began to improve; interest rates and securities were in a positive position. However, there were several crisis-influencing factors at play:
From the latter part of -the 1980s, economic reforms were in place to limit inflation, but cracks began to open as the economy declined. In 1994 the presidential candidate was assassinated, sparking fears of impending currency sell-off. Foreign reserves estimated at around $28 billion to maintain the stability of the Peso disappeared within a year. The Central Bank then tried to shore up the economy by converting short term Peso denominated debt into US dollar-denominated bonds, and this led to increased debt and decreased foreign reserves. Investors set off the crisis when they showed alarm that the Mexican government would default on the debt.
The Mexican government did eventually devalue the currency at the end of 1994, but they had already made major judgment errors by not taking the painful steps to devalue low enough. They also tried to maintain a pegging policy, which allowed investors to force the Peso to drastically low levels. This forced the government to put interest rates to almost 80%, thereby pushing GDP to alarmingly low levels. The only way out of the crisis was to take an emergency loan from the United States.
1997 Asian Crisis
Southeast Asia included Singapore, China, South Korea, and Malaysia and was formerly known as the tiger economies. Foreign investments flooded in, and the underdeveloped economies showed massive growth with exceptionally high export levels. However, productivity did not meet the requirements of the capital investment projects and, while the exact cause for the crisis remains in dispute, Thailand was the first to show signs of ensuing problems.
Thailand, like Mexico, was heavily reliant on foreign debt, and the leading investment sector, real estate, was managed inefficiently. To stay afloat, the private industry relied heavily on foreign investment to maintain massive current account deficits, which exposed the country to considerable Forex risk. The problem peaked when the US increased domestic interest rates, thereby lowering the amount of foreign investment funneled to Southeast Asian economies, triggering a financial crisis among all the countries in the region.
- Fixed exchange rates could not be maintained when currencies in Southeast Asia devalued.
- Because Southeast Asian economies were based on privately held debt with over-inflated asset value, defaults on this debt increased when foreign capital investment declined.
- The fact that investment in the region was, in part, speculative could, in some way, mitigate the responsibility by investors who might not have paid close attention to the risks involved.
Takeaway Lessons from Currency Crises
Any economy can succumb to a currency crisis, and having a low debt figure does not always keep policies working or prevent negative investor opinion.
Low inflation levels and trade surpluses can reduce the impact of the economic crisis. Still, if the seeds of doubt are already sown, and investors smell blood, these short term interventions don’t stem the flow for long, and it is only a matter of time before the crisis becomes fatal.
Governments are often forced to provide liquidity to private bankers who will, in turn, invest in short-term debt, requiring short-term payments. If the government also takes short-term debt investment, it is a one-way ticket to a rapid depletion of foreign reserves.
Maintaining fixed exchange rates and taking measures to retain the peg does sound like sound practice. Still, investors, like hawks, will look at the government’s ability to maintain this policy, and, to maintain credibility, the government is compelled to devalue appropriately and sufficiently.
What are the Features of MTCORE?
- Production is finite, and there is a maximum number of coins produced 100 billion
- The physical guarantee behind MTCORE is Gold [bullion] and a business ecosystem that, with profit, increases MTCORE’s gold reserves.
- MTCORE uses as governance a democratic system that decentralises power and avoids lobbying and market manipulation [pump-n-dump]. In this system, the power is in the users who participate in all decisions.
- The circulation of MTCORE takes place through blockchain, all transactions are public.
- Blockchain has no transaction fees.
- Blockchain has no conflict of interest.
- Blockchain does not invest your coins; they exist at 100%.
- Blockchain does not financially collapse, because it is not an entity that invests money, it is just a digital system that registers and facilitates transactions between users. Therefore, it has no loss.