Will The Fiat Money System Collapse?

In 1971, Richard Nixon single-handedly took the world off the gold standard. Ever since, many commentators have been of the opinion that the monetary system of the world will face a complete collapse. These fears get exaggerated every time there is a crisis.

For instance, during the 2008 crisis, many people felt that the dollar will be highly devalued. Newspaper articles predicting hyperinflation and even the complete collapse of the fiat currency based system were common.

However, such a collapse has not happened. Hence, can it be said that the threat of the collapse of the monetary system is a figment of the imagination of economists who predict economic doom? It seems like the global financial elite has found a way to inflate the currency without having any negative effect on the economy.

In this article, we will have a closer look at how this inflation works.

• Central Banks: Central banks are the key players who help in manipulating the interest rates and keeping them artificially low.

  Central banks also allow other banks with weak balance sheets to continue lending money in the market. This is because the market knows that if the weak bank were to default, the central bank is contractually bound to help it.

  Since the central bank has a monopoly over the production of money, they can never really fall short of money. This is exactly what happened in 2008 when the central bank financed the government’s purchase of toxic assets via the Troubled Assets Relief Program, i.e., TARP.

  The fact of the matter is that investors are not really concerned with the health of solvency of individual banks. Their deposits up to $100,000 per account are insured by the Central Bank. Hence, the mere mention of Central Bank action is enough the calm down an agitated group of investors.

• Policymakers: Central banks have the power to create additional money. However, in most places, they are not authorized to decide how it is spent. This job is done by the government.

  For instance, it was the Congress that decided that banks should be bailed out via the TARP program. The phenomenon of bailouts has become common only in recent years. There is no economic history of government-sponsored bailouts.

  Only in the recent years have governments started pouring in taxpayer money to save failing banks. This has also sent out signals to the investors that the government will not let these institutions fail. This is the reason why investors continue to pour money in these banks even though they know that the leverage ratios are very high and their investment entails high risk.

  Until people believe in the power of the government to bail out the banks, the chances of hyperinflation are low. Hyperinflation is only observed when people start believing that the government has no control over the money creation process.

• Industrialists: In an ideal economy, the market should have crashed more in the year 2008. However, the consumers, workers and the government wanted to prevent such a crash at all costs. As a result, they injected huge sums of money in the banking system. The banking system, in turn, lent out this money to the manufacturers and industrialist. This result was an artificial boom that is created by artificial money.

  The amount of money owed by the industrialists of the world has increased over 50% since 2008. Industrialists are not even paying down the old debt.

  The terms and conditions are so favorable that if an old debt becomes due, it is being refinanced at lower rates instead of being paid off. Hence, the monetary expansion by the central bank is at the root of this boom-bust economy. However, it does not seem to affect the industrialists.

• Investors: The government and the central bank have the same medicine for every ailment. They simply reduce the interest rates and start lending more money. This has changed investor behavior.

  Since the returns from investing are very low, more people tend to spend their money. Also, a lot of unviable projects are being funded by the central bank, and the government isn’t really following due diligence while making these loans.

  The bottom line is that interest rates have been pushed to their lowest possible levels. In some cases, the interest rates are almost zero.

• Reserve Currency: The dollar is the reserve currency of the world. This is one of the biggest reason why America has been able to avoid hyperinflation so far.

  Even though the United States government produces a lot of dollars, other countries hoard these dollars in their reserves.

  Hence, the amount of dollars in circulation in the United States is less. This is the reason why the prices in the United States have not increased even though the money supply has been expanded exponentially. If the other countries found an alternative reserve currency and started dumping the dollar, the inflation rates in America would go up pretty fast.

To sum it up, right now we are facing credit crises. The government is responding to these credit crises by producing more currency. However, if this is done several times, it may end up in the collapse of the monetary system. This means that these doom and gloom predictions are not really that far-fetched.

From an investor’s point of view, this means that a certain percentage of a person’s portfolio must always be kept in tangible non-monetary assets.