The Age of the Fiat Currency: A 38-year experiment in inflation

When the United States closed the gold window in 1971, the world entered a new era in which nearly all money was supported by nothing more than the full faith and credit of the governments issuing it. If one looks back to the history of paper money, no government has had the discipline to maintain its currency without resorting to the printing presses.

All of these paper money experiments have ended in disaster. This is one reason ‘gold bugs’ are so keen on the Gold Standard – because a currency tied to a real asset is better than a currency backed only by the promise of its government not to inflate (a return to Gold is nearly impossible, for reasons I outlined in my post "A New World Order").

But, the era since 1971 is unique in history in that ALL major currencies are fiat currencies. This is truly the Age of the Fiat Currency – unprecedented in human history.

As for how this will all pan out for the United States and elsewhere, Hayman Advisors of Dallas, has a few choice words to say:

As a nation and a world, we are coming to an important crossroad with the belief (whether it be forced or simply accepted) in "fiat" currency. The Old English Dictionary defines “fiat” as:

fiat. [a. Latin ‘let it be done’; ‘let there be made’]

In short, fiat currency is money that exists because an authority, government or custom simply declares or forces it to be as such. The American Heritage dictionary defines fiat currency as "paper money declared legal tender, not backed by gold or silver." I think of fiat currency as being paper money with no intrinsic value which has been simply declared to be legal tender. Up to this point, it has been widely accepted that currency or money is worth the goods and services for which it is routinely exchanged. I hope this remains the case, but think that the odds are against it. In the past, I have stated my belief that there is not enough money in the world to soak up the tens of trillions of dollars of deleveraging that must occur over the next few years. This could not be truer than it is today. While I do not have a solution (and maybe it does not exist) to the problems facing us today, what I do know is that attempting to re-lever a massively over-leveraged system is clearly NOT the answer. The disintermediation of risk is one of the primary causes of the current problem and it is NOT the solution.

Alan Greenspan said it best when he wrote Gold and Economic Freedom in 1966 (before he entered the Federal Reserve System; since then, he has been silent on the subject):

The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit. They have created paper reserves in the form of government bonds which – through a complex series of steps – the banks accept in place of tangible assets and treat as if they were an actual deposit, i.e., the equivalent of what was formerly a deposit of gold. The holder of a government bond or of a bank deposit created by paper reserves believes that he has a valid claim on a real asset. But the fact is that there are now more claims outstanding than real assets. The law of supply and demand is not to be conned. As the supply of money (of claims) increases relative to the supply of tangible assets in the economy, prices must eventually rise. Thus the earnings saved by the productive members of the society lose value in terms of goods. When the economy’s books are finally balanced, one finds that this loss in value represents the goods purchased by the government for welfare or other purposes with the money proceeds of the government bonds financed by bank credit expansion.

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.

This is the shabby secret of the welfare statists’ tirades against gold. Deficit spending is simply a scheme for the “hidden” confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights.

– Alan Greenspan, Gold and Economic Freedom, 1966

Edward here. But, that was the Alan Greenspan of the mid-1960s.  The Alan Greenspan of the mid-1990s was the "Bubble Blower-in-Chief" as Federal Reserve Chairman.  He was a man who believed in the necessity of printing money to avoid the necessary the pain of recession, a economic re-balancing process that is a necessary part of capitalism and a crucial feature of the business cycle.  It is like trying to stay awake at the expense of any sleep.

The problem with this is that the world is awash in fiat money.  Hayman Advisors continues (emphasis added).

To the best of our knowledge, there has only been 160,000 metric tons of gold EVER mined in the world. At $950 per ounce, all of the gold in the world would be worth $4.887 trillion dollars. On the other hand, we estimate that there is roughly $60 trillion of fiat money (including currencies, deposits, savings, money markets and CDs) in the world. Given the fact that world governments are caught with so much credit market leverage and losses, we believe that they will – in true Keynesian color – attempt to print their way out of this mess. If this occurs, you have to ask yourself: How many of people do you think it will take to begin to question the value of paper currency when it is being debased in an attempt to save world governments? If a small fraction of them stop believing, where will they go to preserve their wealth? My guess is the U.S. dollar and precious metals.

Edward again. Wait a minute, U.S. Dollars? Yes, the Greenback. Why? Because as bad as things in the U.S. are, things outside of the U.S. are as bad or worse. Think about some of the countries outside the U.S. like Japan, with their exports imploding. Germany is looking at -6% GDP this year. Hungary,Latvia, and Ukraine are in depression. Spain and Ireland are in Depression. Singapore and Taiwan have entered depression as well. It is not a pretty picture. So, the U.S. Dollar will serve as a safe haven as this deleveraging takes hold.

Here’s how Hayman sees it:

If the Federal Reserve begins to purchase large quantities of newly-issued Treasury bonds – the electronic equivalent of the printing press – we better hold on to our wallets! The good news for the United States is the fact that, as a percent of GDP, it will not have to print nearly as much as many parts of the rest of the world.

What worries me the most about our analysis is the fact that the U.S. will have to issue $2.35 trillion new Treasuries this year, and collectively, Europe will have to issue even more. Today, China and Japan own 65% of the foreign ownership of U.S. Treasuries. Have you seen what is happening to China and Japan lately? It does not seem possible that there is anywhere near enough money in the world to buy that many Treasuries.

To be clear, we believe that the U.S. (and in fact, the world) is in an ongoing debt deflationary spiral that will likely continue for some time (possibly years). The rampant printing of currencies around the globe is not, in our opinion, likely to be immediately “inflationary” (in the common understanding of the term) as leverage comes out of the private sector and asset values continue to decline. The greater concern is the potential inflationary time bomb that grows as governments continue to borrow, print and “stimulate.” What happens to inflation when the velocity of money goes from zero to 100?

Given all of the above, we are very confident in two predictions:

  1. The U.S. is in relatively better shape than the rest of the world, and the dollar will be a safer currency than virtually any other (and yes, that includes the Yen).
  2. Uncertainty and fear are rampant. Confidence in governmental and central bank leadership (are the two really that separate?) is plummeting worldwide. As a result, we believe people will look to “old-fashioned” stores of value – those which represented money long before green pieces of paper backed by a promise existed. Indeed, investors have already begun moving into precious metals. We expect this will continue.

Basically, these guys are more bearish than Nouriel Roubini, Peter Schiff and Michael Panzner combined.

As a result they say:

  1. It’s way too early to take a flyer in bank debt.
  2. It’s not even time to take a flyer in mortgage debt.
  3. Suspending mark-to-market in favour of mark-to-model is a sham. Writedowns will continue.
  4. Interestingly, they do not think Credit Default Swaps are that evil at all.

My thoughts here:  Their analysis is directionally right if extremely bearish.  I happen to think we could see a cyclical rebound as early as Q4 or Q1 of next year.

Nevertheless, we are witnessing the implosion of the Age of the Fiat Currency and its attendant deleveraging.  This is a major event – the most significant economic event n three-quarters of a century.  It would be naive to think it could end in two years as a result of central banks printing money. And then we’d be back to business as normal.  There are many more changes to come.


March 2009 Hayman Advisors Newsletter

  1. Stevie b. says

    Ed. Great post – thanks!

    Seems to echo the discussion we had with hbl on your post about Stephen Roach here:

    However, I’m unconvinced that the dollar is somehow going to emerge as some sort of top dog, thriving in a vacuum & by some sort of default whilst the rest of the world goes to hell in a handbasket. The dollar could be relatively strong, but eventually it wouldn’t mean much if prices were going up just a tad less in the U.S. than elsewhere – and surely this will be the ultimate end-result when interest rate rises (whichever year they come about) will perhaps just be a token gesture in a futile attempt to pretend to be dealing with the rampant global inflation that will occur – just like they’re inadequately pretending to deal with deflation now (so far anyway…)

    As we’ve also discussed before here:

    we do need some sort of clear, fresh parameters for new currencies, but my guess is that before this happens, the current system will be destroyed, including of course all remaining savings. I selfishly hope they can just stretch it all out long enough for me to survive financially til the end of my days, but suspect that one ordinary day in the future and maybe sooner than I’d like, something trivial will occur that will be the last straw for the camel’s back etc, and the whole thing will just blow-up in our faces.

  2. Edward Harrison says

    Stevie, I am not convinced the dollar will be top dog either. I tend to see it as a weak currency longer term. Over the medium-term, yes, the dollar could rally and stay stronger. However, over a longer time horizon, the structural weaknesses will become more important – and that’s as true for the Pound as it is for the dollar.

    I actually would have thought the dollar would have declined by now. However, its resiliency is testament to its preeminent position as a reserve currency and the U.S.’s dominant economic role.

  3. Rob Parenteau says


    Probably best to remember it is not just fiat currency systems that can end in disaster. A gold standard was in place going into the Great Depression, and the first countries that came off of it recovered better than those who remained on it. It is not just fiat currency systems that fail, in other words – commodity currency systems also have a way of derailing. Barry Eichengreen has done some work on this, but he is not the only one.

    Also, there are competing renditions of the history of money and the basis of fiat money which may be of interest. Consider the possibility that fiat currency is “backed” not by some amorphous full faith and credit of the government, but rather by the capacity of the state to impose a liability on its citizens, otherwise known as a tax, and to define what is required to extinguish that liability.

    Finally, seems to me we get into some challenges long before fiscal and monetary stimulus brings any kind of final product price inflation roaring back. With goverment bond yields pulled down to historical lows by zero nominal policy rates and quantitative easing operations, what private agent is going to be willing to accumulate the huge government bond issuance a) knowing the yield on the bond will barely cover any capital loss if and when Treasury yields rise or renormalize and b) the purpose of QE is to force investors to accumulate riskier assets by trashing cash yields and suppressing Treasury, MBS, and even some higher rated corporate debt yields? In other words, if QE is to be successful, government bonds are unlikely to be the asset of choice. Plus, few pension funds or baby boomer households are going to find a 2.75% yield on 10 year US gets them where they need to go after suffering the largest wealth loss since the Great Depression.

    Central banks may end up being the key (only?) bidders at the government bond auctions. As their balance sheets balloon with government bond acquisitions, you may get more investors putting on inflation hedges by accumulating long energy, precious metal, industrial metal, and ag or ag land positions. As those prices rise on stronger investor demand, not stronger end user demand, you introduce adverse shocks to supply curves, as these are generally inputs to final goods production. You also put up the price of essential items like food and energy for consumers. Hard to see how either of these side effects will enhance economic growth. More like a stagflation dynamic, or in the extreme, an almost unthinkable and certainly mindboggling inflationary depression environment.

    Not sure policy makers or professional investors have thought all the way through this, but maybe I am missing something.


    Rob Parenteau, CFA
    MacroStrategy Edge
    Richebacher Letter author

    1. Stevie b. says

      @ Rob Parenteau – re the challenges you mention. Completely agree with your question as to which dummies (apart from C.Bs) are actually going to buy any of this Govmt. stuff, especially notes and bonds. I like your ideas for investment and I like your thought-provoking idea of an inflationary depression – i.e. I don’t like the sound of it at all!

      You can be absolutely sure that you’re missing nothing & policy-makers in particular have not thought-through the consequences of their current actions. They couldn’t care less about tomorrow – they just need to get through today and will worry about tomorrow when it comes. We will see on-going, knee-jerk responses with no defined long-term strategy whatsoever.

    2. Attitude_Check says

      I’ve recently come to the conclusion we will have (and are beginning to have) SIMULTANEOUS asset deflation with consumable/commodity inflation. We actually had the inverse for over a decade (we erroneously attributed asset inflation to economic growth however – doooh!!). We will now have the reverse to rebalence the economic value of production and consuming parts of the world economy. Of course we will almost certainly overcorrect in the process.

      I’m not sure what the best “inflation hedge” will be since typically the use of tangible assets will be deflating. Maybe the best hedge will be in consumable(s) production (e.g. food/farms, necessity products, transportation, green (e.g. domestrically sourced) energy, etc.)

  4. Robert Agans says

    Hello again Edward,
    I just finished reading your two posts – Fiat Currency: A 38-year Experiment, and A New World Order. I found them very interesting and informative, but I wonder if you are familiar with the way that the Bible describes the times and circumstances during this coming period of world economy and government? The foremost reference to this period can be found in the thirteenth chapter of the book of Revelation.
    Someone I think you would find it very interesting to talk to is Gary Kah, a man with a very similar background as yours. He has a brief description on his home page at
    He has written a fascinating book called En Route To Global Occupation describing his experiences and findings as a high-government liaison during the 1980s, hope you have time to examine it or contact Gary.
    In appreciation,
    Robert Agans

  5. Nick Field says

    This article is right on. For a graphic illustration of this point, you can see the real impact of expansionary monetary policy in the inflation rate of the dollar -V- gold since the US left the gold standard. See the current gold dollar price and relative inflation rate of paper dollars at :



  6. Anonymous says

    Whether the US dollar remains the top dog is irrelevant. Many countries are over-leveraged, and producing inflation. The real value all currencies will depreciate over time compared to all goods. Creating inflation only makes things worse for the real economy. Government debt spending removes credit from business. Low interest rates means low yielding dollar, and loose credit will likely be used for less productive activity. Loose credit expands consumer demand, which is the point of it. It’s the perpetual repetition of insanity.

  7. Stephen says

    Yes – very interesting. Question – does one think that the human race in general, broadly speaking would ever advanced as far as we have in terms of business, personal or otherwise without the credit we have received? and without this credit would we still be writing with the chisil and marking the stone in Egypt ? How would have gold fitted in then?

  8. Anonymous says

    Japan should have lowered taxes long ago. That would provide them with a better recovery than all the stimulus combined. No wait! They’d have an even bigger deficit! Well, boo hoo!
    What do you want? Would you like government to a) raise interest rates and cut budget or b) provide some sort of leftist job guarantee? The first might worsen the GFC, the second might lower the impact of the crisis.
    The point is: government spending finances private saving. It doesn’t need savings to spend, doesn’t need taxes to spend, and last but not least, doesn’t need to issue public debt. Not for nothing, it is called ‘fiat currency’.

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