On August 6, 1915, His Majesty’s Government issued this appeal:
In view of the importance of strengthening the gold reserves of the country for exchange purposes, the Treasury have instructed the Post Office and all public departments charged with the duty of making cash payments to use notes instead of gold coins whenever possible. The public generally are earnestly requested, in the national interest, to co-operate with the Treasury in this policy by (1) paying in gold to the Post Office and to the Banks; (2) asking for payment of cheques in notes rather than in gold; (3) using notes rather than gold for payment of wages and cash disbursements generally.
With this obscure and largely forgotten announcement, the Bank of England effectively began the global monetary system’s move away from a gold standard, in which all government and bank obligations were redeemable in physical gold. At the time, gold coins and bars were still used worldwide, but they were of limited use for international trade, which necessitated resorting to the clearance mechanisms of international banks. Chief among all banks at the time, the Bank of England’s network spanned the globe, and its pound sterling had, for centuries, acquired the reputation of being as good as gold.
Instead of the predictable and reliable stability naturally provided by gold, the new global monetary standard was built around government rules, hence its name. The Latin word fiat means “let it be done” and, in English, has been adopted to mean a formal decree, authorization or rule. It is an apt term for the current monetary standard, as what distinguishes it most is that it substitutes government dictates for the judgment of the market. Value on fiat’s base layer is not based on a freely traded physical commodity, but instead is dictated by authority, which can control its issuance, supply, clearance, and settlement and even confiscate it at any time it sees fit.
Saifedean Ammous is an economist and author of “The Bitcoin Standard.” He is currently writing a sequel, “The Fiat Standard,” as well as an economics textbook, “Principles of Economics.” You can subscribe to receive one chapter a week from the two books on his website, saifedean.com.
With the move to fiat, peaceful exchange on the market no longer determined the value and choice of money. Instead, it was the victors of world wars and the gyrations of international geopolitics that would dictate the choice and value of the medium that constitutes one half of every market transaction. While the 1915 Bank of England announcement, and others like it at the time, were assumed to be temporary emergency measures necessary to fight the Great War, today, more than a century later, the Bank of England is yet to resume the promised redemption of its notes in gold. Temporary arrangements restricting note convertibility into gold have turned into the permanent financial infrastructure of the fiat system that took off over the next century. Never again would the world’s predominant monetary systems be based on currencies fully redeemable in gold.
The above decree might be considered the equivalent of Satoshi Nakamoto’s email to the cryptography mailing list announcing Bitcoin. But, unlike Nakamoto, the U.K. government provided no software, white paper, nor any kind of technical specification as to how such a monetary system could be made practical and workable. Unlike the cold precision of Satoshi’s impersonal and dispassionate tone, it relied on appeal to authority, and emotional manipulation of its subjects’ sense of patriotism. Whereas Satoshi was able to launch the Bitcoin network in operational form a few months after its initial announcement, it took two world wars, dozens of monetary conferences, multiple financial crises, and three generations of governments, bankers, and economists struggling to ultimately bring about a fully operable implementation of the fiat standard in 1971.
Fifty years after taking its final form, and one century after its genesis, an assessment of the fiat system is now both possible and necessary. Its longevity makes it unreasonable to keep dismissing the fiat system as an irredeemable fraud on the brink of collapse, as many of its detractors have done for decades. Many people at the end of their life today have never used anything but fiat money, and neither did their parents. This cannot be written off as an unexplained fluke, and economists should be able to explain how this system functions and survives, despite its many obvious flaws. There are, after all, plenty of markets around the world that are massively distorted by government interventions, but they nonetheless continue to survive. It is no endorsement of these interventions to attempt to explain how they persist.
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It is also not appropriate to judge fiat systems based on the marketing material of their promoters and beneficiaries in government-financed academia and the popular press. While the global fiat system so far avoided the complete collapse its detractors would predict, that doesn’t make it a free-lunch-maker with no opportunity cost or consequence. More than fifty episodes of hyperinflation have taken place around the world using fiat monetary systems in the past century, according to the work of economist Steven Hanke. Moreover, the global fiat system avoiding catastrophic collapse is hardly enough to make the case for it as a positive technological, economic and social development.
Between the relentless propaganda of its enthusiasts and the rabid venom of its detractors, this book attempts to offer something new: an exploration of the fiat monetary system as a technology, from an engineering and functional perspective, outlining its purposes and common failure modes, and deriving the wider economic, political, and social implications of its use. I believe that adopting this approach to writing “The Bitcoin Standard” contributed to making it the best-selling book on bitcoin to date, helping hundreds of thousands of readers across more than 20 languages understand the significance and implications of bitcoin. Rather than focus on the details of how bitcoin operates, I chose to focus on why it operates the way it does, and what the implications are.
Perhaps counter-intuitively, I believe that by first understanding the operation of bitcoin, you can then better understand the equivalent operations in fiat. It is easier to explain an abacus to a computer user than it is to explain a computer to an abacus user. A more advanced technology performs its functions more productively and efficiently, allowing a clear exposition of the mechanisms of the simpler technology, and exposing its weaknesses. For the reader who has become familiar with the operation of bitcoin, a good way to understand the operation of fiat is by drawing analogy to the operation of bitcoin using concepts like mining, nodes, balances and proof-of-work. My aim is to explain the operation and engineering structure of the fiat monetary system and how it operates, in reality, away from the naive romanticism of governments and banks who have benefited from this system for a century.
The fiat system explained
How does the fiat system actually function, in an operational sense? The success of bitcoin in operating as a bare-bones and standalone free market monetary system helps elucidate the properties and functions necessary to make a monetary system function. Bitcoin was designed by a software engineer who boiled a monetary system down to its essentials. These choices were then validated by a free market of millions of people around the world who continue to use this system, and currently entrust it to hold more than $300 billion of their wealth.
The fiat monetary system, by contrast, has never been put on a free market for its users to pass the only judgment that matters on it. The all-too-frequent systemic collapses of the fiat monetary system are arguably the true market judgment emerging after suppression by governments. With bitcoin showing us how an advanced monetary system can function entirely independently of government control, we can see clearly the properties required for a monetary system to operate on the free market, and in the process, better understand fiat’s modes of operation, and all-too-frequent modes of failure.
While fiat systems have not won acceptance on the free market, and though their failings and limitations are many, they have facilitated an unfathomably large number of transactions and trades all around the world. Its continued operation makes understanding it useful, particularly as we still live in a world that runs on fiat. Just because you may be done with fiat does not mean that fiat is done with you! Understanding how the fiat standard works, and how it frequently fails, is essential knowledge for being able to navigate it.
To begin, it’s important to understand that the fiat system was not a carefully, consciously, or deliberately designed financial operating system like bitcoin; rather, it evolved through a complex process of compromise between political constraints and expedience. I illustrate this by examining historical documents on just how the fiat standard was born, and how it replaced the gold standard, beginning in England in the early twentieth century, completing the transition in 1971 across the Atlantic.
Contrary to what the name suggests, modern fiat money is not conjured out of thin air through government fiat. Government does not just print currency and hand it out to a society that accepts it as money. Modern fiat money is far more sophisticated and convoluted in its operation. The fundamental engineering feature of the fiat system is that it treats future promises of money as if they were as good as present money because the government guarantees these promises.
While such an arrangement would not survive in the free market, the coercion of government can maintain it for a very long time. Government can meet any present financial obligations by diverting them onto future taxpayers or onto current fiat holders through taxes or inflation; and, further, through legal tender laws, a government can prevent any alternatives to its money from gaining traction. By leveraging their monopoly on the legal use of violence to meet present financial obligations from potential future income, government fiat makes debt into money, forces its acceptance across society, and prevents it from collapsing.
In the book, I examine how the fiat network’s native tokens come into existence, using fiat’s antiquated and haphazard version of mining. As fiat money is credit, credit creation in a fiat currency results in the creation of new money, which means that lending is the fiat version of mining. Fiat miners are the financial institutions capable of generating fiat-based debt with guarantees from the government and/or central banks. Unlike with bitcoin’s difficulty adjustment, fiat has no mechanisms for controlling issuance. Credit money, instead, causes constant cycles of expansion and contraction in the money supply with eventual devastating consequences.
The Federal Reserve – the central node in the fiat system – is the only institution that can validate or refuse any transaction on any layer of the network. Another 200 or so central bank nodes are spread around the world, and these have geographic monopolies on financial and monetary services, where they regulate and manage tens of thousands of commercial bank nodes worldwide. Unlike with bitcoin, the incentive for running a fiat node is enormous. The enormous incentive to mine fiat by issuing debt means individuals, corporations, and governments all face a strong incentive to get into debt. The monetization and universalization of debt is also a war on savings, and one which governments have prosecuted stealthily and mostly quite successfully against their citizens over the last century.
The two obvious uses of fiat are that it allows for government to easily finance itself, and that it allows banks to engage in maturity-mismatching and fractional reserve banking while largely protected from the inevitable downside. But the third use of fiat is the one that has been the most important to its survival: salability across space.
From the outset, I will make a confession. Attempting to think of the fiat monetary system in engineering terms and trying to understand the problem it solves have resulted in giving me an appreciation of its usefulness, and a less harsh assessment of the motives and circumstances which led to its emergence. Understanding the problem this fiat system solves makes the move from the gold standard to the fiat standard appear less outlandish and insane than it had appeared to me while writing “The Bitcoin Standard,” as a hard money believer who could see nothing good or reasonable about the move to an easier money. Fiat may have been a huge step backward in terms of its salability across time, but it was a substantial leap forward in terms of salability across space.
Having laid out the mechanics for the operation of fiat in the first section, the book examines the economic, societal, and political implications of a society utilizing such a form of money with uncertain and usually poor inter-temporal salability. This section focuses on analyzing the implications of two economic causal mechanisms of fiat money: the utilization of debt as money, and the ability of a government to grant this debt at essentially no cost.
Fiat increasingly divorces economic reward from economic productivity, and instead bases it on political allegiance. This attempted suspension of the concept of opportunity cost makes fiat a revolt against the natural order of the world, in which humans, and all other animals, have to struggle against scarcity every day of their lives. Nature provides humans with reward only when their toil is successful, and similarly, markets only reward humans when they are able to produce something that others value subjectively. After a century of economic value being assigned at the point of a gun, these indisputable realities of life are unknown to, or denied by, huge swathes of the world’s population who look to their government for their salvation and sustenance.
The suspension of the normal workings of scarcity through government dictat has enormous implications on individual time preference and decision-making, with important consequences to many facets of life. In the second section of the book, we explore the impacts of fiat to family, food, education, science, health, fuels, and security.
While the title of the book refers to fiat, this really is a book about bitcoin, and specifically the question what will the relationship between fiat and bitcoin be in the coming years?
While “The Bitcoin Standard” focused on bitcoin’s intertemporal salability, “The Fiat Standard” examines how bitcoin’s salability across space is the mechanism that makes it a more serious threat to fiat than gold and other physical monies with low spatial salability. Bitcoin’s high salability across space allows us to monetize a hard asset itself, and not credit claims on it, as was the case with the gold standard.
At its most basic, bitcoin increases humanity’s capacity for long-distance international settlement by around 500,000 transactions a day, and completes that settlement in a few hours. This is an enormous upgrade over gold’s capacity, and makes international settlement a far more open market, much harder to monopolize. This also helps us understand bitcoin’s value proposition as not just in being harder than gold, but also in traveling much faster. Bitcoin effectively combines gold’s salability across time with fiat’s salability across space in one apolitical immutable open source package.
By being a hard asset, bitcoin is also debt-free, and its creation does not incentivize the creation of debt. By offering finality of settlement every ten minutes, bitcoin also makes the use of credit money very difficult. At each block interval, the ownership of all bitcoins is confirmed by tens of thousands of nodes all over the world. There can be no authority whose fiat can make good a broken promise to deliver a bitcoin by a certain block time. Financial institutions that engage in fractional reserve banking in a bitcoin economy will always be under the threat of a bank run as long as no institution exists that can conjure present bitcoin at significantly lower than the market rate, as governments are able to do with their fiat.
With this foundation, the book can tackle the question: how can bitcoin rise in the world of fiat, and what are the implications for these two monetary standards coexisting? In the final chapters, I analyze different scenarios in which bitcoin continues to grow and thrive, and conversely where bitcoin fails.
Whereas “The Bitcoin Standard” explained the properties that make bitcoin a compelling alternative to modern central banks, “The Fiat Standard” examines whether bitcoin can continue to rise in a world dominated by fiat, whether it can improve on fiat’s properties, and how the political system will react to this rise.