Fiat currency is bad for many more reasons beyond the obvious one – that it loses purchasing power due to inflation.
It has many other negative economic, political and social qualities.
However, it is important to acknowledge the one benefit of fiat currency. Many hard money advocates don’t want to admit that fiat has any redeeming qualities.
But I think it’s worth doing that first and then we’ll jump into the list of 15 reasons why fiat currency is bad.
The One Benefit of Fiat Currency
If you listen to some hard money people they will tell you that fiat is a cold blooded conspiracy designed to rob you of your wealth and destroy civilization.
It certainly is tempting to look at it that way since ultimately those are its effects.
However, there is another angle, best outlined by Saifedean Ammous in his book The Fiat Standard.
The argument is that fiat currency emerged as a response to one of the key problems of the gold standard – monetary salability across space.
Saifedean defines salability as “the ease with which a good can be sold on the market whenever its holder desires, with the least loss in its price.”
Gold preserves its value over time but is cumbersome to transport in large quantities over great distances.
Gold worked well in small to medium sized economies.
But in the global marketplace that emerged in the 21st century, the gold standard had some flaws.
What fiat did and still does well is transfer value across space.
Saifedean Ammous explains:
“The fiat standard initially appears as a deliberate nefarious conspiracy to destroy human civilization. But writing this book, and thinking very hard about the operational reality of fiat, has brought into sharper focus the property of salability across space, and in the process, made the rationale for the emergence of the fiat standard clearer, and more comprehensible. For all its many failings, there is no escaping the conclusion that the fiat standard was indeed a solution to a real and debilitating problem with the gold standard, namely its low spatial salability. More than any conspiracy, the limited spatial salability of gold as global trade advanced allowed the survival of the fiat standard for so long… 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.”
Why Fiat Currency Is Bad
Now that we have acknowledged the benefit of fiat currency, let’s look at all of its flaws.
1. Loss of Purchasing Power Due To Inflation
This is the most well known of fiat currency’s many failings.
The supply of fiat is continuously being increased and therefore the value of existing units of fiat currency is continuously being eroded.
This means that there is little incentive to save your money as it is guaranteed to lose value over time.
The unfortunate thing is that many people are either blissfully unaware of this inflation tax or consider it to be perfectly normal.
2. Fiat Currency Is Based On Trust In Government And Central Banks
Hard money like gold and Bitcoin derives its value from the subjective views of the free market.
On the other hand, fiat currency’s value comes from its status as legal tender and the confidence the users of the currency have in the government maintaining its solvency and the central bank maintaining the soundness of the currency.
The problem is that this trust is easily eroded. When it is eroded to such a severe point, the currency may lose all its value.
This is an incredibly shaky foundation on which to base a currency.
3. Fiat Has A Poor Historical Record
Every fiat currency eventually fails.
The ones currently in circulation will fail, just as every historical fiat currency has failed.
If you issue a currency that is not backed by any valuable commodity and ask people to trust in the credit worthiness of the government and central bank, then you inevitably create a recipe for failure.
Empires, nations and regimes all eventually fail. And their currencies fail as well as people reject fiat money for real assets such as real estate and precious metals.
4. The Cantillon Effect
18th century economist Richard Cantillon famously observed that increases in the money supply did not lead to an even rise in prices.
That is because an increase in the supply of money is not evenly distributed across the population.
Those who receive the new money are enriched, while those who do not become poorer.
The mechanics of the fiat monetary system means that new money is accessed by government and those who have access to credit i.e. businesses and mortgage holders.
The new money first lifts asset prices and then lifts consumer prices.
Those holding assets benefit, while those who work for wages and don’t own a home suffer the most.
This leads to a growing wealth divide.
“In the modern fiat standard, the beneficiaries of the Cantillon effect are the borrowers and the victims are savers.Spending less than you earn and keeping savings on hand are simply no longer optimal financial strategies; they are expensive luxuries most cannot afford.”
5. Fiat Is Centrally And Politically Controlled
Fiat currency is centrally planned money.
For example, the monetary policy of the US Dollar is determined by the Federal Reserve Board of Governors.
Bitcoin, on the other hand, is politically neutral money with monetary policy set by its code.
The problem is that monetary policy is not determined by what is in the best interests of the existing holders of the currency.
It is determined by what bureaucrats deem to be in the best interests of the nation. They might get it right sometimes, but mostly they get it terribly wrong.
6. Fiat Has No Supply Schedule Or Hard Cap
The quantity of fiat currency has no limit. Nor do we know into the future how much currency will be created or destroyed.
We are completely beholden to the planning decisions of the central bank.
Gold, on the other hand, also has no upper limit. But we know that there is approximately 1.5% added to the total supply each year. This is still somewhat uncertain but it is much more predictable than fiat.
Hard money cryptocurrencies like Bitcoin and Monero have monetary policies governed by code. We can simply do the math and work out the supply schedule. It is plain for all market participants to see.
For example, Bitcoin has a total limit of 21 million coins. New Bitcoins are issued to miners every ten minutes as a block reward. The block reward is cut in half every four years until all 21 million coins are mined.
Monero has no limit on the total number of coins. But it has a block reward of 0.6 XMR per block, which means the rate at which new Monero comes onto the market is completely transparent and predictable and is low relative to the existing supply.
7. Fiat Currency Gives Massive Power To The Reserve Currency
Gold and Bitcoin are neutral international money.
Fiat currency is not. Each fiat currency is issued and controlled by a nation.
In the fiat system the nation who has the reserve currency, currently the United States, wields enormous power.
The reserve currency nation gains influence over global trade, can use its monetary policy to influence global economic conditions and is given the “exorbitant privilege” of running persistent trade deficits that allow it to export inflation.
8. Fiat Currency Does Not Meet The Requirements To Be Sound Money
Greek philosopher Aristotle said that for something to be money it needed the following characteristics:
- Intrinsic Value
We can make a few amendments to that list based on our modern understanding. Intrinsic value can be removed, as the Austrian branch of economics has shown that intrinsic value does not exist.
We should also add fungibility and scarcity.
Based on these characteristics, fiat currency is an inferior form of money when compared to both Bitcoin and gold.
Its most compelling failure is its lack of scarcity, which immediately rules it out as sound money.
9. Fiat Currency Uses Coercion
In a free market for money, fiat would probably disappear. At the very least its use would be greatly reduced.
People would favour hard money alternatives like gold, Bitcoin and Monero.
But fiat currency has been made legal tender. We are required to pay our taxes in it.
This coercive aspect ensures the demand for the currency.
Saifedean Ammous describes this coercive aspect in The Bitcoin Standard:
“A few reasons keep government money as the prime money of our time. First, governments mandate that taxes are paid in government money, which means individuals are highly likely to accept it, giving it an edge in its salability. Second, government control and regulation of the banking system means that banks can only open accounts and transact in government-sanctioned money, thus giving government money a much higher degree of salability than any other potential competitor. Third, legal tender laws make it illegal in many countries to use other forms of money for payment.”
10. Fiat Currency Has Counterparty Risk
Fiat currency has two main counterparty risks.
The first is banking system risk if you hold your fiat in a bank account. A deposit in a bank account is actually an unsecured loan to the bank. What you think is your money actually becomes a liability on the bank’s balance sheet. If the bank fails, chances are you will not see your fiat again.
The second counterparty risk is sovereign risk. Since a fiat currency is issued by a nation-state, the stability of the currency depends on the political, economic and financial stability of that nation. Fiat currencies can and do collapse in value on account of geopolitical instability, economic crisis, high inflation or defaults on debt.
Only gold or Bitcoin in cold storage have no counterparty risk.
11. Fiat Currency Is Debt Based Money
Saifedean Ammous defines fiat currency as “a compulsory implementation of debt-based centralized ledger technology monopolizing financial and monetary services worldwide.”
New units of fiat currency are created whenever new debt is issued. Fiat currency is not money in the traditional sense of the term. Instead it is better seen as credit and is a liability on the issuing government’s balance sheet.
The incentives of the fiat system mean that it is strategic to go into as much debt as one can manage and use the currency to buy hard assets.
12. Fiat Currency Places Limited Restraint On Government Spending
There are only three ways a government can raise revenue:
Under a hard money standard, governments are limited to taxation and borrowing as they have little scope to increase the money supply through inflation.
Therefore government spending is limited. They have to be careful not to over tax the population as it will lead to a fall in revenue. They also need to be careful not to borrow too much as it will affect their creditworthiness and since they can’t inflate, they must repay the debt through taxation.
Under a fiat standard a government can tax, borrow and inflate. The traditional handbrakes on government spending are not there and inflation allows governments to spend beyond their means.
This is why the classical gold standard was abandoned at the outset of World War One. Governments found it easier to finance the war through money printing than through taxation.
13. Fiat Currency Creates A Moral Hazard
Fiat currency creates a moral hazard because banks and financial institutions take on risks that they would not in a hard money standard.
They know that they can get bailed out by a government or a central bank.
There is always a lender of last resort who can print money.
The bail out can be funded by the creation of new currency units, something that is not possible under a hard money standard.
Hard money incentivises conservative stewardship of money. Fiat currency encourages excessive risk and recklessness.
14. Fiat Currency Destroys Capital
Fiat currency loses value when you hold it. Therefore you are incentivised to consume it quickly rather than save it.
Keynesian economists mistakenly believe this is a good thing because they believe that consumption drives economic growth.
However, the Austrians correctly explain that economic growth is driven by capital accumulation and capital accumulation comes from savings and investment.
Unlike a fiat currency, hard money that maintains or increases in value encourages savings and investment.
If fiat currency encourages consumption and discourages savings, then it will inevitably shrink the amount of capital available for economic growth.
Even worse, the inflation that occurs in a fiat currency system distorts price signals and leads to misallocation of resources in the economy. The result is capital destruction.
As Saifedean explains:
“Central bank manipulation of its monopoly currency leads to distorting the ability of entrepreneurs to perform economic calculation, leading to systematic errors in allocation of capital, which are exposed when credit expansion recedes, leading to the recessionary bust part of the business cycle. Each such business cycle causes large amounts of misallocation of capital into unprofitable and unproductive ventures that effectively consume capital rather than increase it. Credit unbacked by savings cannot generate new capital for investment, it can only misallocate existing capital to sectors where the action of self-interested individuals in a free market would not have allocated it.”
15. Fiat Currency Creates Distorted Incentives
Fiat currency distorts the economy by allowing individuals, businesses and government to accumulate debt more easily at lower cost.
This leads to malinvestments and incentivises present consumption over prudent financial management and long term savings.
People develop short term thinking and a high time preference.
As Saifedean explains:
“The culture of conspicuous mass consumption that pervades our planet today cannot be understood except through the distorted incentives fiat provides to consume. With the money constantly losing value, deferring consumption and saving will likely have a negative expected value. Finding the right investments is difficult, requires active management and supervision, and entails risk. The path of least resistance, and the one permeating the entire culture of fiat society is to consume all your income.”
Fiat currency has numerous disadvantages that far outweigh its one redeeming quality.
While it has high salability across space it causes significant economic, political and social problems. The most obvious one being the destruction of purchasing power across time.
Fiat displaced the gold standard in the 20th century to become the dominant monetary system of the world. With Bitcoin, we now have an alternative hard money system that provides salabiltiy across space without the loss of purchasing power and other destructive aspects of fiat.
Ammous, Saifedean. The Bitcoin Standard : The Decentralized Alternative to Central Banking Hoboken, New Jersey: John Wiley & Sons, Inc, 2018.
———. The Fiat Standard. Saif House, 2021.