Fiat currency is an attractive thing for a government.
They can use it to transfer wealth from the future to the present and therefore they can spend beyond their means.
Taxation and borrowing have limitations, but creating new units of currency is a much easier method of government financing.
Unfortunately for governments there is one thing that limits their ability to use fiat currency.
That is the willingness of the citizens to adopt and use the money.
Sometimes they can be coerced into it over the short term. But in the long term, if the government mismanages and debases the currency then the citizens will reject it.
The history of fiat currency is more or less the same in each circumstance. The government prints too much, creates inflation or hyperinflation and the currency is rejected.
Every fiat currency has failed because eventually fiat ceases to function as a store of value and a medium of exchange. When that occurs people will return to forms of money that can hold value.
Here is a brief history of 9 fiat currency failures.
1. Imperial Chinese Paper Money
The Chinese were the first to invent paper money. This took different forms across different imperial dynasties.
The first widespread paper money was the jiaozi that circulated in modern day Sichuan during the Song Dynasty.
This paper was initially a receipt for the deposit of iron money which was exchanged amongst the population as money. The governor allowed 16 families to manage this currency privately, although the government later decided to take over the currency management themselves.
It did not take long before supply started to increase and inflation was triggered. Soon they had to discontinue the jiaozi and replace it with a new currency, the qianyin.
After the Jin Dynasty was established in Northern China, the Song reorganised as the Southern Song Empire. In 1161 a new currency, the huizi was established across the empire. This became the first national paper currency.
The government understood the risks of paper money and placed strict controls on the money supply.
These controls did not last long and the temptation to print became too strong.
The huizi was printed in huge quantities, triggering the first nationwide paper money inflation.
The Yuan Dynasty that followed had their own paper currency, the jiaochao. Initially this was backed by silk or silver and was convertible. But it did not take long for the Yuan to print far more money than they had commodities backing it.
The currency was rejected and citizens had to resort to barter.
The Ming Dynasty also used fiat currency. Their version was called the baochao.
The government stipulated that this was the only currency to be used, however this decree was not widely enforced.
Chinese citizens had long since figured out not to trust government paper and preferred to use silver instead.
The more the baochao was inflated, the less the citizens wanted to use it. Eventually even government officials refused to have their salaries paid in it. The government finally recognised this reality and gave up on trying to force the baochao on the population.
Silver was restored to full monetary status.
2. John Law’s Paper Money Disaster in France
John Law was a Scotsman who introduced the first paper money to France in 1716.
He had befriended the Duke of Orleans, who was the regent for the child king Louis XV, and convinced him that paper money was the way to get the French government out of debt.
Initially, this new paper money was limited in supply and was convertible to gold and silver.
Two years later the supply limitation was removed.
The Bank that had been set up to manage the currency printed more and more notes.
Around the same time, Law had established the Mississippi Company and had acquired a monopoly on France’s foreign trade.
In what became the famous Mississippi bubble, huge demand for the shares in the Mississippi Company drove the share price from 500 livres to 18,000 livres.
During the speculative mania the government continued to print more and more paper money.
Eventually the smart money started taking profits, which triggered a collapse in the stock price of the Mississippi Company.
This was a wise move as inflation had reached 23%.
But it would destroy the monetary system.
Law initially responded by suspending convertibility into gold and silver and devaluing the paper currency by 50%. But this could not save the system.
The collapse of both the stock price of the Mississippi Company and the paper currency created chaos in France.
Law fled the country and the government returned to a monetary system based on gold and silver.
3. The Assignat of the French Revolution
It did not take the French long to make the same mistake again.
At the start of the French Revolution the National Assembly decided that the way out of the fiscal hole they were in was fiat currency.
The nation still bore the scars of the John Law experiments but this time they thought it would be different. This time they thought they would be able to control the fiat currency more effectively.
They were wrong.
The temptation to issue ever increasing amounts of fiat currency was too great for the revolutionaries to resist.
Within five years of the first issue, the new paper currency, the assignat, had lost 99% of its value.
Prices skyrocketed as the country descended into political, social and economic chaos.
It took Napoleon to restore financial order. He reorganised the monetary system based on gold and silver with the silver/gold ratio set at 15:1.
4. Hyperinflation in the Early Soviet Union
When war broke out in 1914 Russia abandoned the gold standard, along with the other belligerent powers. This was so they could finance the war through the printing press.
Russia suffered heavily in the war with huge numbers of casualties, shortages of goods and skyrocketing inflation.
When the Communists took over in 1917 the nation was in disarray. They withdrew from World War One but the country then descended into a long civil war between Communist and anti-Communist forces.
Despite the incredible hardship caused by both wars Lenin, the Communist leader, still pursued his fanciful and destructive economic ideas.
This included financing his communist ideology through printing money, with the eventual aim of abolishing money altogether.
Lenin thought money was a capitalist anachronism.
Eventually reality caught up to the Soviet Communists and they were forced to rethink their policies.
As part of their New Economic Policy they backed the Soviet currency with gold. Money printing to cover budget deficits was forbidden.
5. Hyperinflation in Weimar Germany
The hyperinflation of Weimar Germany is perhaps the most famous fiat currency failure in history.
Germany too abandoned the gold standard at the start of World War One and printed money to pay for the costs of war.
The inflation actually started during the war as shortages and money printing drove prices higher.
Germany’s loss at the hands of the allies and the subsequent reparations payments made things worse.
By 1922 prices were doubling every month and strikes occurred as workers demanded higher wages.
Wages rose but the cost of living rose much faster.
In January 1923 the German government fell behind on their wartime reparations payments, so France and Belgium invaded.
The German printing presses went into overdrive to cover the lost production and pay striking workers.
Prices continued to rise in an obscene manner and the nation was thrown into total chaos. Farmers refused to accept paper currency in exchange for their products and so there were food shortages in the cities.
The hyperinflation was solved by introducing a new temporary currency called the rentenmark. This currency was backed by mortgages on land and bonds on German industry.
This was an inconvertible currency that too was fiat. But its theoretical backing with hard assets gave the public enough confidence in the currency to make it work.
With the stability provided by the rentenmark, the allies were prepared to deal with Germany to find a long term solution.
The 1924 Dawes Plan gave Germany a loan of $200 million dollars. This was to pay reparations for a year, recapitalise the Reichsbank and to build up the nation’s gold reserve.
This gave Germany the reserves it needed to then issue a long term currency, the Reichsmark, with a 40% gold cover in October 1924.
6. Hyperinflation in The Republic of China
The Republic of China adopted a formal silver standard in 1933 after many years of preparation.
They had intended to move to a gold standard eventually.
Unfortunately for China, they got their timing really wrong. In 1934 the USA passed the Silver Purchase Act, which compelled the US government to buy silver to support domestic production.
This sent silver prices higher, which caused deflation in China. Additionally, silver prices became higher in the USA than they were in China, which resulted in an outflow of the metal and a shortage of currency.
Prior to the Silver Purchase Act, China actually had the highest international price for silver, which had caused significant silver inflows.
The government decided to take over the banking sector and introduce a paper currency.
While they had originally planned on moving from a silver standard to a gold standard they decided they was now little point, after the USA became the final country to abandon gold in 1933.
The Republic of China decided to go straight from silver to paper.
In 1935 they introduced the fabi, an inconvertible fiat currency and ordered all citizens to hand in their silver. The government used the silver to buy US dollars to act as reserves for the fabi.
When Japan invaded China in 1937, the government inflated the currency to finance the war effort.
Between the start of the war in 1937 and the end of the war in 1945 the money supply increased over 400x.
When the Chinese Civil War restarted after the defeat of the Japanese, the Nationalist government continued to inflate the currency.
The fabi was replaced in 1948 by the gold yuan but that too failed and in 1949 the Nationalist government retreated to Taiwan and the Communists established the People’s Republic of China.
The inflation of the fabi played a significant role in the Nationalists losing the Chinese Civil War as it eroded their support amongst the middle class who saw their wealth disappear before their eyes.
7. Hyperinflation in Post Soviet Russia
In 1985, when the last Soviet leader Mikhail Gorbachev embarked on his series of economic reforms, the inflation rate of the Soviet Union was 4.6%.
The Soviet economy was very unhealthy and Gorbachev recognised that if things did not change, the nation’s economy would decline significantly.
Gorbachev thought his economic reforms would preserve the socialist system and make it more efficient.
Instead it exposed the weaknesses of the Soviet economy and the system as a whole. As Gorbachev opened up the economy and the political system, things spiralled out of his control.
By 1990 inflation reached 19%. By the end of 1991 it was 200%.
Gorbachev’s political and economic reforms resulted in the disintegration of the Soviet Union as a political entity in 1991.
Russia, the successor state, continued to battle with inflation as it attempted to restore political and economic order.
However the Russian government was unsuccessful and the inflation rate reached 2,318% by the end of 1992.
It is estimated that more money had been printed in 1991 than the previous 30 years.
The high inflation of the Russia Rouble continued until 1995 when the government brought inflation under control by pegging the currency to the US Dollar.
8. Hyperinflation in Zimbabwe
In the late 1990s, the Mugabe government in Zimbabwe enacted a series of land reforms which evicted white farmers in favour of black farmers.
Without the same level of experience, the new farmers were less productive than those who previously worked the land.
Food production fell and prices rose.
White Zimbabweans left the country and took their capital with them.
Economic sanctions were applied to Zimbabwe by the USA, the EU and the IMF. This led to the banking sector collapsing.
Around the same time, Zimbabwe was fighting a war in the Democratic Republic of the Congo. They were financing this conflict by printing money.
With the economy in disarray and unemployment rising, printing money became an attractive option to finance all the governments needs.
The combination of fewer goods and more units of currency in supply led to an explosive hyperinflation which peaked in 2008 at 79,600,000,000%.
Citizens got around this by using foreign currency, particularly US dollars as a means of exchange.
This had been illegal but eventually the government relented and accepted reality, allowing the use of foreign currency in 2009.
The US Dollar has been the dominant currency ever since.
9. Hyperinflation in Venezuela
Venezuela’s economy and therefore their currency is highly dependent on oil.
When demand for oil is high there is a corresponding demand for Venezuelan Bolivars to buy their oil. When demand for oil is low the demand for Bolivars falls away.
In 2014 there was a significant drop in the oil price and demand for Bolivars fell away sharply.
As the value of the Bolivar declined, the cost of imported goods rose.
New President Nicholas Maduro decided that his solution to the problem was to print more money.
This made the situation worse as international investors were reluctant to commit their money to the country and Venezuelans started selling their local currency for foreign currencies to protect themselves.
Maduro then implemented currency controls which created a thriving black market of US dollars.
From an inflation rate of 69% in 2014, Venezuela reached an inflation rate of 1,700,000% in 2018.
Enormous numbers of Venezuelans fled the country during the crisis.
In 2019 Maduro relaxed some economic controls, allowing the US dollar to circulate alongside the Bolivar.
In December 2021 Venezuela exited hyperinflation according to the textbook definition of a lower than 50% monthly inflation rate for 12 months.
However, the Bolivar is still experiencing extremely high inflation. In October 2022 the annual inflation rate was 155.8%.
The success of fiat currency relies on the ability of the monetary authority to maintain the soundness of the currency over a long period.
Some governments and monetary authorities can keep a fiat currency alive for quite a long time, especially if it has some degree of gold backing. Others are far more short-lived.
However, the temptation of money printing that fiat currency allows is extremely seductive. Even those who understand the need for restraint eventually give in.
Fiat currencies come and go. What always remains is hard money such as gold and silver.
The US Dollar began its life as a fixed weight of silver, then it became a fixed weight of gold. Now it is a purely fiat currency without being bound to hard money.
That it has been used to stabilise hyper inflationary conditions in Zimbabwe and Venezuela only serves to illustrate that as the global reserve currency it is the most stable currency in the world.
Nevertheless as a fiat currency, it too cannot last forever. It will fail as every fiat currency in history has failed (with the exception, of course, of those still in circulation).
We should prepare for that fact now, while times are still good, and make sure we are protected with some hard money when it is inevitably needed.
Zimbabwean Dollars is in the public domain
Jiaozi is in the public domain
Assignat is in the public domain
Papiermark is in the public domain
Fabi is in the public domain