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Commodity Currency Vs Fiat Currency

December 4, 2014

Economic activity consists quite simply of the voluntary exchange of goods and services. Literally everybody, unless they are severely disabled in some way, is capable of entering into this activity. It is in fact an activity which is essential for human survival.

It is however an activity which is logistically very difficult to execute because finding a person with matching needs and potential offerings is not easy. The level of difficulty was significantly reduced however when the concept of a general purpose means of exchange [GPME] was accepted. Suddenly you could get something that you wanted by giving its owner sufficient GMPE in exchange for the desired item and the erstwhile owner could then exchange the received GPME with somebody else to gain possession of something that they wanted. The whole exchange process was still fully completed but suddenly it was relieved of one of the major inherent difficulties. As a natural consequence of this, GPME’s, now known as money, became regarded as an integral and, in a sense, an essential part of any economic exchange.

For ease of understanding it is worth noting that when money is used in the exchange process special terminology is used to distinguish between the two halves of a completed exchange. When somebody uses money to acquire an item they are a purchaser, or some other similar term, and when somebody receives money for an item they are a seller, or some other similar term.

There was a downside to the general acceptance of the GPME concept however and this arose out of efforts to ensure that the users of GPME’s need never fear that their GPME’s would lose exchangeable value. This required that the GMPE’s, i.e. the money, had real economic value besides being a GPME. This meant that a GPME had also to be a real exchangeable good in itself. Thus it was that goods such as precious metals like gold became used as GPME’s.

The consequence of GMPE’s having real value right from the time of issuance was that  GMPE’s had to be earned from others who already had them. This requirement inevitably gave rise to poverty for some people as entry into the exchange process now required prior possession of GPME’s either by the entrant themselves or by their possible exchange partner(s). Thus a poor person who lived in a poor community had very little chance of ever being able to enter into a completed exchange process involving GMPE’s as they were highly unlikely to find someone to enter into the process with them who was already in possession of the necessary GMPE’s.

Things are, potentially, different now however as we are blessed with a fiat currency. A fiat currency is not legally bound to the intrinsic value of a physical, and therefore limited, commodity such as gold but instead derives its value from the value of the first completed exchange in which it participates. Fiat currencies are never compelled to be linked to an exchangeable good like gold. Fiat currencies are just recordings of value and thus open the way to money playing its primary role for everybody, whether they have any money or not, and that is, to facilitate exchanges of real goods and services.

Our trouble is that although we have a fiat currency our money system has not currently been adjusted to exploit the opportunity that a fiat currency provides. The money system  thus continues, in many ways, to function as if the currency was based on a commodity, i.e. gold. So right now our money cannot wholly fulfill its primary role for everyone. Under the current money system any person, who is without sufficient money to enter into an exchange, is unable to do so because they cannot be issued with new money to make a purchase even if they could subsequently sell something of value equal to that of the newly issued money.

A commodity based currency plays the exchange facilitative role but only to a limited extent. The limitation derives from the fact that when a unit of a commodity based currency is introduction into circulation it already has to have a real fraction of the commodity linked to it. Thus it cannot just be issued to someone who needs it to enter into an exchange except as a gift  or as charity, i.e. Social Grants. This is because the receiver has not earned it through an exchange, equivalent in value, of goods and/or services.

New units of a fiat currency on the other hand can be issued to any one who needs them, to enter into an exchange, because the value of the units derives not from a commodity such as gold but from the completion of the first exchange in which the newly issued currency participates, i.e. purchase followed by a sale, by the first user of the new money, equivalent in value to the new money. The currency received from the sale being used to off-set the new money debt of the first user of the new money.

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