Sunday, December 15, 2013

Fiat Money is a Bubble

Sometimes, offhand comments contain an astonishing depth of perception.  Such was the case in a recent Nick Rowe comment.  In an brief comment on another's words, Nick writes "When people hear the word "bubble" they don't think about currency. But currency is a bubble, and this post is reminding people that it is a bubble."  As I read that comment, I was startled to think "HOW TRUE!".

Now I do not want anyone to think Nick put a lot of thought into this comment, nor do I want anyone to give Nick a lot of credit for insight here, nor should he be criticized in any way.  I take it as an offhand comment that contains much more truth than first is evident.  It is perhaps, an unintended caricature.

Fiat currency really is a "bubble".  Modern fiat money is a bubble.  Consider how it is generated or initiated:

Fiat money can come initially either from banks or government.  (Counterfeit money is ruled out of consideration because it is unlawful.)  Having no backing, fiat money begins as a promise.

Banks issue fiat money by creating a deposit and taking a contractual promise in return.  The promise stays at the bank (or may be sold) but the deposit circulates throughout the economy.

Governments issue fiat money in the identical way.  Government may borrow from the local bank or an individual.  Government also has the option of borrowing from it's own bank usually called a Central Bank.  No matter where borrowed from, government is trading a promise for a deposit.  The deposit is then spent into the economy.

Thus we see that fiat money is the result of a promise.  Bubbles are the froth following promise, perhaps enhanced with hope and high expectations.  Fiat money really IS a bubble.

Later, when we want to become much more academic, we should consider how fiat money becomes valuable.  Promises are the the substance of bubbles; promises are risky and can be vaporous.

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