Fiat money is money that derives its value from government regulation or law. The term fiat currency is used when the fiat money is used as the main currency of the country. The term derives from the Latin fiat (“let it be done”, “it shall be”)
Fiat money originated in 11th century China, and its use became widespread during the Yuan and Ming dynasties. During the 13th century, Marco Polo described the fiat money of the Yuan Dynasty in his book The Travels of Marco Polo. The Nixon Shock of 1971 ended the direct convertibility of the United States dollar to gold. Since then all reserve currencies have been fiat currencies, including the U.S. dollar and the Euro.
Yuan dynasty banknotes were the earliest fiat money.
The term fiat money has been defined variously as:
- any money declared by a government to be legal tender.
- state-issued money which is neither convertible by law to any other thing, nor fixed in value in terms of any objective standard.
- money without intrinsic value.
While gold- or silver-backed representative money entails the legal requirement that the bank of issue redeem it in fixed weights of gold or silver, fiat money’s value is unrelated to the value of any physical quantity. Even a coin containing valuable metal may be considered fiat currency if its face value is higher than its market value as metal.
The Song Dynasty in China was the first to issue paper money, jiaozi, around the 10th century AD. Although the notes were valued at a certain exchange rate for gold, silver, or silk, conversion was never allowed in practice. The notes were initially to be redeemed after three years’ service, to be replaced by new notes for a 3% service charge, but, as more of them were printed without notes being retired, inflation became evident. The government made several attempts to support the paper by demanding taxes partly in currency and making other laws, but the damage had been done, and the notes fell out of favor.
The successive Yuan Dynasty was the first dynasty in China to use paper currency as the predominant circulating medium. The founder of the Yuan Dynasty, Kublai Khan, issued paper money known as Chao in his reign. The original notes during the Yuan Dynasty were restricted in area and duration as in the Song Dynasty.
All these pieces of paper are, issued with as much solemnity and authority as if they were of pure gold or silver… and indeed everybody takes them readily, for wheresoever a person may go throughout the Great Kaan’s dominions he shall find these pieces of paper current, and shall be able to transact all sales and purchases of goods by means of them just as well as if they were coins of pure gold.
—Marco Polo, The Travels of Marco Polo
During the 13th century, Marco Polo described the fiat money of the Yuan Dynasty in his book The Travels of Marco Polo. In 1661, Johan Palmstruch issued the first regular paper money in the West (although Washington Irving records an earlier emergency use of it, by the Spanish in a siege during the Conquest of Granada), under royal charter from the Kingdom of Sweden, through a new institution, the Bank of Stockholm. While this private paper currency was largely a failure, the Swedish parliament eventually took over the issue of paper money in that country. By 1745, its paper money was inconvertible to specie, but acceptance was mandated by the government. Fiat money also has other roots in 17th century Europe, having been introduced by the Bank of Amsterdam in 1683.
18th and 19th century
An early form of fiat currency in the American Colonies were “bills of credit”. Provincial governments produced notes which were fiat currency, with the promise to allow holders to pay taxes in those notes. The notes were issued to pay current obligations and could be called by levying taxes at a later time.
Since the notes were denominated in the local unit of account, they were circulated from person to person in non-tax transactions. These types of notes were issued particularly in Pennsylvania, Virginia and Massachusetts. Such money was sold at a discount of silver, which the government would then spend, and would expire at a fixed point in time later.
Bills of credit have generated some controversy from their inception. Those who have wanted to highlight the dangers of inflation have focused on the colonies where the bills of credit depreciated most dramatically – New England and the Carolinas. Those who have wanted to defend the use of bills of credit in the colonies have focused on the middle colonies, where inflation was practically nonexistent.
Colonial powers consciously introduced fiat currencies backed by taxes, e.g. hut taxes or poll taxes, to mobilise economic resources in their new possessions, at least as a transitional arrangement. The repeated cycle of deflationary hard money, followed by inflationary paper money continued through much of the 18th and 19th centuries. Often nations would have dual currencies, with paper trading at some discount to specie backed money.
Examples include the “Continental” issued by the U.S. Congress before the Constitution; paper versus gold ducats in Napoleonic era Vienna, where paper often traded at 100:1 against gold; the South Sea Bubble, which produced bank notes not backed by sufficient reserves; and the Mississippi Company scheme of John Law.
During the American Civil War, the Federal Government issued United States Notes, a form of paper fiat currency popularly known as ‘greenbacks’. Their issue was limited by Congress just slightly over $340 million. During the 1870s, withdrawal of the notes from circulation was opposed by the United States Greenback Party. The term ‘fiat money’ was used in the resolutions of an 1878 party convention
By World War I most nations had a legalized government monopoly on bank notes and the legal tender status thereof. In theory, governments still promised to redeem notes in specie on demand. However, the costs of the war and the massive expansion afterward made governments suspend redemption in specie. Since there was no direct penalty for doing so, governments were not immediately responsible for the economic consequences of printing more money, which led to hyperinflation – for example in Weimar Germany.
Attempts were made to reassert currency stability by anchoring it to wholesale gold bullion rather than making it payable in specie. This money combined pure fiat currency, in that the currency was limited to central bank notes and token coins that were current only by government fiat, with a form of convertibility, via gold bullion exchange, or via exchange into US dollars which were convertible into gold bullion, under the 1945 Bretton Woods system.
From 1944 to 1971, the Bretton Woods agreement fixed the value of 35 United States dollars to one troy ounce of gold.
Other currencies were pegged to the U.S. dollar at fixed rates. The U.S. promised to redeem dollars in gold to other central banks. Trade imbalances were corrected by gold reserve exchanges or by loans from the International Monetary Fund. This system collapsed when the United States government ended the convertibility of the US dollar for gold in 1971, in what became known as the Nixon Shock.
Chartalism is a monetary theory that states the initial demand for a fiat currency is generated by its unique ability to extinguish tax liabilities. Goods and services are traded for fiat money due to the need to pay taxes in the money.
Loss of backing
A fiat-money currency generally loses value once the issuing government or central bank refuses to further guarantee its value, but this need not necessarily occur. For example, the so-called Swiss dinar continued to retain value in Kurdish Iraq even after its legal tender status was withdrawn by its issuer, Iraq’s central government.
In monetary economics, fiat money is an intrinsically useless product, used as a means of payment. In some micro-founded models of money, fiat money is created internally in a community making feasible trades that would not otherwise be possible, either because producers and consumers may not anonymously write IOUs, or because of physical constraints.
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Executive Order 6102 is an Executive Order signed on April 5, 1933, by U.S. President Franklin D. Roosevelt “forbidding the Hoarding of Gold Coin, Gold Bullion, and Gold Certificates within the continental United States”. The order criminalized the possession of monetary gold by any individual, partnership, association or corporation
The order was rationalized on the grounds that hard times had caused “hoarding” of gold, stalling economic growth and making the depression worse. The New York Times, on April 6, 1933 p. 16, wrote under the headline “Hoarding of Gold”, “The Executive Order issued by the President yesterday amplifies and particularizes his earlier warnings against hoarding. On March 6, taking advantage of a wartime statute that had not been repealed, he issued Presidential Proclamation 2039 that forbade the hoarding ‘of gold or silver coin or bullion or currency,’ under penalty of $10,000 and/or up to five to ten years imprisonment.”
Effect of the order
Executive Order 6102 required all persons to deliver on or before May 1, 1933, all but a small amount of gold coin, gold bullion, and gold certificates owned by them to the Federal Reserve, in exchange for $20.67 (equivalent to $371.10 today) per troy ounce. Under the Trading With the Enemy Act of 1917, as amended by the recently passed Emergency Banking Act of March 9, 1933, violation of the order was punishable by fine up to $10,000 (equivalent to $180 thousand today) or up to ten years in prison, or both. Most citizens who owned large amounts of gold had it transferred to countries such as Switzerland.
Order 6102 specifically exempted “customary use in industry, profession or art”—a provision that covered artists, jewellers, dentists, and sign makers among others. The order further permitted any person to own up to $100 in gold coins (a face value equivalent to 5 troy ounces (160 g) of Gold valued at about $7800 as of 2011). The same paragraph also exempted “gold coins having recognized special value to collectors of rare and unusual coins.” This protected recognized gold coin collections from legal seizure and likely melting.
Hear Franklin D Roosevelt Fireside Banking Chat March 12, 1933
The price of gold from the Treasury for international transactions was thereafter raised to $35 an ounce ($587 in 2010 dollars) resulting in an immediate loss for everyone who had been forced to surrender their gold. The resulting profit that the government realized funded the Exchange Stabilization Fund established by the Gold Reserve Act in 1934.
The regulations prescribed within Executive Order 6102 were modified by Executive Order 6111 of April 20, 1933, both of which were ultimately revoked and superseded by Executive Orders 6260 and 6261 of August 28 and 29, 1933, respectively.
Executive 6102 also led to the ultra-rarity of the 1933 Double Eagle gold coin. The order caused all gold coin production to cease and all 1933 minted coins to be destroyed. About 20 illegal coins were stolen, leading to a standing United States Secret Service warrant for arrest and confiscation of the coin. A legalized coin sold for over 7.5 million dollars, making it the most valuable coin in the world, almost double its nearest competition.
Invalidation and reissue
There was only one prosecution under the order, and in that case the order was ruled invalid by federal judge John M. Woolsey, on the grounds that the order was signed by the President, not the Secretary of the Treasury as required.
The circumstances of the case were that a New York attorney, Frederick Barber Campbell, had on deposit at Chase National over 5,000 troy ounces (160 kg) of gold. When Campbell attempted to withdraw the gold Chase refused and Campbell sued Chase. A federal prosecutor then indicted Campbell on the following day (September 27, 1933) for failing to surrender his gold. Ultimately, the prosecution of Campbell failed, but the authority of the federal government to seize gold was upheld, and Campbell’s gold was confiscated.
The case forced the Roosevelt administration to issue a new order under the signature of the Secretary of the Treasury, Henry Morgenthau, Jr., which was in force for a few months until the passage of the Gold Reserve Act on January 30, 1934.
Abrogation and subsequent events
The Gold Reserve Act of 1934 made gold clauses unenforceable, and changed the value of the dollar in gold from $20.67 to $35 per ounce. This price remained in effect until August 15, 1971, when President Richard Nixon announced that the United States would no longer convert dollars to gold at a fixed value, thus abandoning the gold standard for foreign exchange (see Nixon Shock).
The private ownership of gold certificates was legalized in 1964. They can be openly owned by collectors but are not redeemable in gold. The limitation on gold ownership in the U.S. was repealed after President Gerald Ford signed a bill to “permit United States citizens to purchase, hold, sell, or otherwise deal with gold in the United States or abroad” with an act of Congress codified in Pub.L. 93–373,which went into effect December 31, 1974. P.L. 93-373 did not repeal the Gold Repeal Joint Resolution, which made unlawful any contracts that specified payment in a fixed amount of money as gold or a fixed amount of gold. That is, contracts remained unenforceable if they used gold monetarily rather than as a commodity of trade. However, Act of Oct. 28, 1977, Pub. L. No. 95-147, § 4(c), 91 Stat. 1227, 1229 (originally codified at 31 U.S.C. § 463 note, recodified as amended at 31 U.S.C. § 5118(d)(2)) amended the 1933 Joint Resolution and made it clear that parties could again include so-called gold clauses in contracts formed after 1977.
The myth of a safe deposit box seizures order
According to a folk rumor on the internet, President Roosevelt ordered all the safe deposit boxes in the country seized and searched for gold by an I.R.S. official. A typical example reads:
By Executive Order Of The President of The United States, March 9, 1933.
By virtue of the authority vested in me by Section 5 (b) of the Act of October 6, 1917, as amended by Section 2 of the Act of March 9, 1933, in which Congress declared that a serious emergency exists, I as President, do declare that the national emergency still exists; that the continued private hoarding of gold and silver by subjects of the United States poses a grave threat to the peace, equal justice, and well-being of the United States; and that appropriate measures must be taken immediately to protect the interests of our people.
Therefore, pursuant to the above authority, I hereby proclaim that such gold and silver holdings are prohibited, and that all such coin, bullion or other possessions of gold and silver be tendered within fourteen days to agents of the Government of the United States for compensation at the official price, in the legal tender of the Government.
All safe deposit boxes in banks or financial institutions have been sealed, pending action in the due course of the law. All sales or purchases or movements of such gold and silver within the borders of the United States and its territories and all foreign exchange transactions or movements of such metals across the border are hereby prohibited.
Your possession of these proscribed metals and/or your maintenance of a safe deposit box to store them is known by the government from bank and insurance records. Therefore, be advised that your vault box must remain sealed, and may only be opened in the presence of an agent of the Internal Revenue Service.
By lawful order given this day, the President of the United States.
Franklin Roosevelt—March 9, 1933
Most of this text does not appear in the actual Executive Order. In fact, safe deposit boxes held by individuals were not forcibly searched or seized under the order and the few prosecutions that occurred in the 1930s for gold hoarding were executed under different statutes. One of the few such cases occurred in 1936, when a safe deposit box containing over 10,000 troy ounces (310 kg) of gold belonging to Zelik Josefowitz, who was not a U.S. citizen, was seized with a search warrant as part of a tax evasion prosecution.
The U.S. Treasury came into possession of a large number of safe deposit boxes due to bank failures. During the 1930s, over 3,000 banks failed and the contents of their safe deposit boxes were remanded to the custody of the Treasury. If no one claimed the box, it remained in the possession of the Treasury. As of October 1981, there were 1,605 cardboard cartons in the basement of the Treasury, each carton containing the contents of one unclaimed safe deposit box.
Similar laws in other countries
In Australia part IV of the Banking Act 1959 allowed the Commonwealth government to seize private citizens’ gold in return for paper money where the Governor-General “is satisfied that it is expedient so to do, for the protection of the currency or of the public credit of the Commonwealth.” As of January 30, 1976, this part’s operation is “suspended”.
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Eric Rauchway Bloomberg.com Mar 21, 2013
On March 4, 1933, Franklin D. Roosevelt became president for the first time, promising an “adequate but sound” currency. The next day, a Sunday, he closed the nation’s banks. “We are now off the gold standard,” he privately declared to a group of advisers. Goldbugs in the president’s circle immediately began prophesying doom. One of his aides, Lewis Douglas, proclaimed “the end of Western civilization.”
How Roosevelt took this fateful step has been the subject of debate among historians, many of whom believe that the president flailed his way through his first weeks in office, and only gradually came to the decision to take the country off gold that April. But the evidence suggests that Roosevelt intended to do so from Day One for very specific reasons, although he delayed letting the rest of the country in on his plans.
Minutes after FDR had made his unsettling private disclosure, a secretary told him that reporters were clamoring to know if the U.S. had left the gold standard. “Tell them to ask a banker,” Roosevelt said. He clearly did not yet wish to say the truth publicly. First, he needed depositors to return the gold they had withdrawn in panic in the weeks preceding his inauguration.
By Tuesday, Americans had begun to bring gold in large quantities back to the banks. Perhaps they were shamed by the president’s identifying hoarding as the source of the panic, or maybe they feared prosecution under new penalties, including a tax on hoarding, then being discussed in Washington as ways of ensuring that gold came back to the Treasury. The Federal Reserve announced that it had the names of those who had taken out gold… >>MORE(Bloomberg.com)
Hear Franklin D Roosevelt Fireside Banking Chat March 12, 1933
Nathan Lewis Forbes 3/14/2013
FOR A LONG TIME, gold standard advocates in the United States have had differing viewpoints about whether a new gold standard system might take place with existing institutions, such as the Federal Reserve, or whether it would take place with new institutions, and the Federal Reserve would in effect be disbanded or rendered irrelevant, writes Nathan Lewis of New World Economics.
During the 1980s or 1990s, it seemed politically impossible to even consider a situation in which the existing monetary plumbing would be torn out and replaced with some “free banking system” or other such solution. The Fed, under Greenspan and Volcker, seemed to have a pretty good handle on things. The economy was doing well and people were enjoying a Great Bull Market in both stocks and bonds. This was not the time when you throw everything overboard for some goofy new idea…(snip)
…Let’s see what Alan Greenspan has been saying recently:
“We have at this particular stage a fiat money which is essentially money printed by a government and it’s usually a central bank which is authorized to do so. Some mechanism has got to be in place that restricts the amount of money which is produced, either a gold standard or a currency board, because unless you do that all of history suggest that inflation will take hold with very deleterious effects on economic activity… There are numbers of us, myself included, who strongly believe that we did very well in the 1870 to 1914 period with an international gold standard.”
In the same January 2011 interview, Greenspan apparently wondered out loud if we even require a central bank!….>>MORE(forbes.com)
Urs Geiser, swissinfo.ch Mar 20, 2013
A rightwing group has submitted more than 106,000 signatures to the federal authorities, seeking a vote on stopping the sale of gold reserves held by the Swiss National Bank (SNB). It also wants gold bars stored in the US to be returned.
The group, led by members of the Swiss People’s Party, the far-right Swiss Democrats and the Lega dei Ticinesi movement, is confident a nationwide vote will be called on the issue once the signatures are verified. A date still has to be set by the government… >>MORE(swissinfo.ch)
The world’s largest gold bar stands at 250 kg (551 lb), measuring at the base 45.5 cm × 22.5 cm and 17 cm high with 5 degree draft angle (equal to 15730 cm³, or 17.9 in × 8.9 in × 6.7 in≈1062.04 in³). It was manufactured by the Mitsubishi Materials Corporation, a subsidiary of Mitsubishi. It went on display at the Toi gold mine on July 11, 2005. Its gold content was valued in 2005 at 400 million yen (approximately US$3,684,000 at the time though at current 2013 gold prices its is worth approximately US $13.5 million (value calculated is for gold weight alone @ $1,676/troy ounce, not accounting for the premium associated with being the world’s largest gold bar).
A kinebar is a gold bar which contains a Kinegram to prove its authenticity. Kinegram is a trademark of OVD Kinegram Corp. (Switzerland). A kinegram is a diffractive security device embossed into a substrate (here gold). It is intended both as a security feature and for visual appeal.
Union Bank of Switzerland, through its subsidiary refinery, Argor-Heraeus SA, has applied the kinegram as a security device to the reverse of its minted bars since December 1993. The kinebar, now produced by UBS AG, is a registered trade mark of UBS.
21 Mar, 2013 The Economic Times
KOZHIKODE: A 21-year-old passenger, who arrived from Dubai, has been arrested at the airport here on charge of attempting to smuggle one kg gold biscuits valued at Rs 28.48 lakh, officials said today.
Shamu Ali, hailing from Thamarassery in the district, was found carrying the gold biscuits hidden in the base of a table lamp…>>(MORE)(TheEconomicTimes)