A fiat currency is one that has no intrinsic value of its own, and its perceived value comes from a government decree and the mandated use of that currency to pay taxes. Fiat currencies rely heavily on the confidence of the public. Many of you will have heard the quote from over 300 years ago that says that “paper money eventually returns to its intrinsic value of zero” (Voltaire, 1694-1778). What are the mechanisms by which currencies disappear?
In 2008, Mike Hewitt showed that of all currencies have ever existed, only 23% are still in existence right now, 19% were destroyed by hyperinflation, and the remaining 58% are no longer in circulation.
Let’s look more closely at the data for the currencies that are no longer in circulation. There are 609 such currencies. The median currency age was 17 years which seems rather short but the range was huge (1 month to 591 years). The currency that lasted as long as 591 years was the French livre. The fate of these 609 currencies is shown in the pie chart above. Thirty one percent disappeared through monetary reforms, dissolution, or other kinds of reforms and a relatively recent example of this is the loss of a whole bunch of European currencies to form the Euro in 1999. Only 16% of currencies ended through acts of Independence, such as when former colonies renamed or reformed their own currencies. Twenty seven percent of currencies were destroyed by acts of war and indeed the second world war saw at least 95 currencies vanish. Finally 26% of currencies were destroyed through hyperinflation, as a result of over issuance of the currency by the government. This data is very interesting brings up a whole host of additional questions. The currencies in this study that were a mixed bag with some evolving over time. For example, the British pound started out on a gold standard and then it went bi-metallic, and then became fiat, The median age of the currency doesn’t tells us the whole picture since we’re not measuring apples with apples.
- How many of those currencies were purely fiat at some point?
- How long was the lifespan of that currency from the time it became fiat to the end?
- What was the mechanism or cause of the pure fiat currency ending?
- How does the fate of fiat currencies compare to the fate of gold-backed currencies?
The answers to these questions will be very enlightening and would help inform us about the future of many of the currencies that are currently in circulation.
As far as existing currencies go, there are 176 currencies in circulation. The median age is 37 years but again the range is very large (7 months (venezuelan bolivar) to 315 years (British Pound)). The vast majority (if not all) of currencies that exist at the moment are purely fiat, and they are either floating or pegged to another currency such as the US dollar. This is a situation that has no historical precedent. Notably, all existing fiat currencies have depreciated relative to gold in the past century.
The chart above shows that the level of fiat depreciation against gold has not been minor. In fact all currencies have lost at least 90% of their purchasing power over time.
Whatever the fate of your currency, the everyday person will somehow lose out. For example if your currency remains in circulation, its purchasing power is going to continue to diminish. The other possibility is inflation and hyperinflation which is going to destroy the purchasing power even more. In the event of a war, the public never benefits from that. That just leaves us with a change of the currency by independence or reform and it is hard to believe that the ticket doesn’t get clipped during that process.
It could be argued that the world’s reserve currency would fare quite differently from other smaller currencies. Although currency strength is an important property for a reserve currency, it is not the most important factor. For example in the long term, the Swiss franc has been a better store of value than the US dollar. Therefore, in addition to strength, the reserve currency must come from a dominant and stable economy. There must be access to a wide range of financial assets denominated in that currency, and the volume of financial instruments in the market must also be large. There should also be a high level of liquidity so that transactions are easy, but also large transactions can be made without affecting price significantly.
The chart above shows very clearly how the global reserve currency status has changed hands approximately every hundred years. It would be interesting to view the data for each of these currencies at the beginning and the end of their reign, and see what properties each of those currencies had. It is likely that each currency would have had a significant tie to gold at the start. Near the end, that currency would probably have devalued relative to gold, meanwhile the currency and economy of another country would have been strengthening and its currency then goes on to swoop in and take over the reserve status. The currency that takes over reserve status has some tie to gold. So there seems to be a recurring pattern throughout history. An increase in spending, easy credit, sanctions on free trade, war, and empire building also seemed to have played a central role in loss of reserve status in the past. Constant devaluation also plays a big part.
What can we conclude about the fate of the US dollar? We are in a situation where all currencies are fiat and there is no-non fiat alternative currency in circulation that currently fits the requirements of a potential reserve currency. Could we get a simultaneous global hyperinflation? Although that is a possibility, more likely is monetary reform. If history is anything to go by, gold would be involved in that reform in some way and if that is the case then what are the implications for countries whose central banks don’t hold any gold? What you think the fate of your own currency is going to be?
Gold and Silver Assets 