Fiat currency summary

It’s been suggested to me that understanding of my fiat currency discussion might be aided by a summary of the main threads of my argument. So here goes:

In the first article I introduced the thought experiment. Two scenarios were compared.

In one, the dollar was replaced by the pound, which was to be worth twice as much as the dollar; everyone ends up with debts and credits of half as many pounds as they had dollars.

In the other scenario, the dollar was not replaced by the pound, but half of everyone’s physical currency disappeared, and creditors forgave half of every debt owed to them.

We noted that in the second scenario, everyone owns and owes as many dollars as they would own and owe pounds in the first scenario. So the question was whether we should expect the dollar in the second scenario to be worth the same as the pound in the first scenario.

In the second article, we saw that yes, simultaneously halving all the money and debts would have the tendency to double the value of the dollar, although that tendency might be slowed by inertia, and interfered with by regulations that assume a fairly stable currency value.

Why? Because otherwise the value of the dollar must be set solely by people’s expectations of the value of the dollar, rather than by anything fundamental. But the Reserve Bank is expected to control the gradual decline in the value of the dollar, and they seem to be relatively successful; do they really have that much influence over our collective baseless beliefs?

The next article considered whether halving the stock of money without halving the debts would have the same effect of doubling the value of the dollar.

The article concluded that it wouldn’t have the full effect, because otherwise we could imagine a coalition of sufficiently many creditors that could profit by throwing away money. The more money they throw away, the more they profit, until they’ve thrown away all the money, and the coalition (and all net creditors) are infinitely wealthy, while net debtors owe debts representing infinite wealth. This is clearly absurd.

The conclusions were:

  • That debts are fundamental to the value of a fiat currency; debtors form the base demand for that currency.
  • Although forgiving someone’s debt helps that person, it can sometimes harm other people who owe money in that fiat currency. This effect would be limited or non-existent for currencies that represent specific commodities.
  • Similarly, if a debtor becomes more productive, then that debtor is better off, but other debtors may be worse off. Again, this depends on the currency used being a fiat currency.
  • I’m not completely sure of this point, but it might even be the case that the continued existence of a fiat currency entails that creditors believe that there will never be an end to cases of debtors being on the brink of defaulting on their debts.

Finally, I compared the lack of guarantees that a fiat currency provides to debtors and to creditors. For creditors, there’s no lower limit to what they might get for their credits. For debtors, there’s no upper limit to what might be required of them to pay off their debts.

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