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All of the
major central banks hold currency reserves in the form of gold or other
national currencies, but it is not strictly true that these reserves
"back" the associated currencies. For example, if the US' gold
reserves or Japan's US$ reserves disappeared tomorrow, the US$ and the Yen
wouldn't be worth any less than they are today. What, then, backs today's
fiat money?
That's a
trick question, because money isn't backed by anything. Money is what it is
-- the most commonly used final means of payment within the economy. For
example, when the US was on something close to a genuine "gold
standard" during the last quarter of the 19th Century, gold was money
and the gold wasn't backed by anything. Pieces of paper known as dollars
circulated within the economy during this period, but the paper dollars
weren't money; rather, they were receipts for money (gold) held in a vault
somewhere. Of course, banks created more receipts for money than there was
actual money, but this fraudulent practice -- known as fractional reserve
banking -- is a separate issue.
Some people
will no doubt argue that gold money wouldn't need to be backed by anything
because gold has "intrinsic value", whereas paper or electronic
money needs to be backed by something because it has no "intrinsic
value". The problem with this line of thinking is that gold and paper money
have exactly the same "intrinsic value": zero. All value is
subjective. What, for instance, would gold bullion be worth to you if you
were stranded alone on a desert island with no hope of ever being rescued? In
that situation, a tree that provided a steady supply of coconuts would
probably have a lot more value to you than one million ounces of gold.
However, if you were living in a modern economy and the government was acting
in a way that was guaranteed to destroy wealth and substantially reduce the
purchasing power of the official money, gold would probably be very valuable
to you. The point is that the value of any object is in the eye of the
beholder; it is never inherent in the object.
Once
something has taken on the role of money, its value, like the value of
everything else, will be determined by its supply relative to its demand. The
difference is that with money it really comes down to supply, because while
changes in demand are often important on a short- or intermediate-term basis
the long-term trend in the purchasing power of money will almost always be
dominated by the change in the money supply*. Given that under today's
monetary system the central bank determines the long-term growth rate in the
supply of money, it is fair to say that the central bank (the Fed in the US)
is by far the biggest influence on the value of modern money. However, the
central bank is really just a tool of the government and the banking system,
so if we take a step back we can see that the ability of today's money to
maintain its usefulness as money is largely dependent upon the
policies/actions of the government and the major private banks.
Therein lies
the problem. The problem isn't that today's money is not "backed"
by much in the way of reserves; the problem is that the value of YOUR money
is determined by the actions of ethically-bankrupt institutions.
*Note that we
aren't implying, here, that there is a linear relationship between changes in
the money supply and changes in money purchasing power, because that definitely
isn't the case. Changes in the money supply have a non-uniform effect on
prices within the economy, and there are often long and variable delays
between changes in money supply and the resultant changes in money purchasing
power. We are simply saying that the long-term shift in a currency's
purchasing power will primarily be determined by the change in its supply.
Steve Saville
www.speculative-investor.com
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