Introduction
One of the most commonly cited truisms of psychology is that the best predictor of future behavior is past behavior. I’m sure that you have much evidence that bears this out from your own life and also from those you know well. I can tell you for sure that it is strongly aligned with my general experience, both personally and as a psychotherapist. Sigmund Freud aptly referred to one variant of this principle as the “repetition compulsion.” The ancient Greeks recognized a similar predictable pattern that they called “hamartia,” the fatal flaw in character that leads predictably to the downfall of the protagonist in a tragedy, who is said to “walk in blindness.”
With regard to humans repeatedly making the same dumb mistakes over and over again, it sadly seems to hold true across the broad spectrum from individuals to nation states. The 18th century British statesman and philosopher, Edmund Burke, summed up this seemingly lawful principle in his often quoted aphorism: “Those who don’t know history are destined to repeat it.”
The consequences of this unfortunate human proclivity have historically entailed tremendous suffering for humankind. Accordingly, I want to focus here on the history of a particularly dramatic instance of it that has unfolded repeatedly and lawfully in the economies of nation states over the past 2500 years or more.
This recurring pattern can be summarized most simply as follows: The accumulation of excessive debt through the creation of fiat currencies that are not backed by gold, silver, or other precious metals leads progressively to hyperinflation and then to the eventual economic collapse of the governments that follow this reckless course.
Some History and Definition of Terms
In order to convey adequately how this repetitive self-defeating pattern unfolds, it will be helpful to define some key basic terms and provide some historical background. First of all, it’s important to understand the difference between “money” and “currency.” Although these two terms are commonly used interchangeably, they actually have distinctively different technical meanings. Money is intrinsically valuable; that is, it stores value in and of itself, quite apart from being used as a means of exchange. Currency, by contrast, has NO intrinsic value and is used ONLY as a means of exchange.
Down through the history of humanity, a wide variety of items have been used as money, or more specifically, “commodity money”. They have included such things as red ochre, sea shells, ivory, whale’s teeth, as well as various commodities (e.g., salt and spices). Interestingly, when a commodity becomes socially defined as money, its value may be increased above its intrinsic worth or usefulness; also, its value commonly fluctuates over time accordingly to the demand for it and/or its prevalence.
In order for a commodity to become conventionally defined as money, it must be fairly easy to transport, durable so that it can be stored for prolonged periods of time without deteriorating, and sufficiently rare to hold its value. Given these criteria, it is not surprising that gold and silver have commonly served as money for thousands of years and, over the past twenty-five centuries, have become its most prevalent form, spreading from Asia Minor across the entire world.
This conventional practice was facilitated by the discovery of the “touchstone” around the 6th century B.C. This made it possible to do a quick assay of gold and silver to determine their degree of purity.
Since gold and silver are relatively soft metals, they are subject to becoming significantly worn or deformed through daily use. In order to increase their durability, therefore, they are commonly alloyed with less expensive metals, such as copper. Common examples of such alloys are sterling silver or 22 carat (92%) gold.
Over time, commodity money gradually evolved into “representative money” as a result of bankers issuing paper receipts or other representative tokens to their depositors. These receipts or “notes” indicated that they were redeemable for whatever goods were being stored (usually gold or silver). This soon led into these notes being traded as money with the understanding that they were “as good as gold;” that is, their bearers could redeem them at any time for the amount of silver or gold that they represented. They were, in other words, gold-backed or silver-backed notes.
It was through this practice, for example, that the paper currency called the “British Pound” evolved. Since it was backed by a pound of sterling silver, it came to be called the Pound Sterling. This general practice was widely emulated by many other nations that elected to back their various currencies with gold throughout much of the nineteenth and twentieth centuries. This became generally known as the “gold standard.”
As these notes became widely trusted and utilized as a medium of exchange, bankers (or goldsmiths) observed that it was very rare for people to redeem all of their notes at the same time. This led them to the avaricious realization that they could invest a portion of these gold reserves into interest-bearing loans and thereby generate additional income. This left them, however, on a slippery slope with more notes on issue than reserves with which to pay them. It also set in motion an evolutionary process whereby goldsmiths were transformed from being passive guardians of gold and silver bullion, who charged fees for safe storage, into the wealthy interest-paying and interest-earning bankers of today.
Moreover, it ushered in the highly lucrative modern practice of fractional-reserve banking. This refers to the fraction of its total reserve assets that a bank can legally use in issuing loans to its customers. This fraction is most commonly fixed at 10%, but can be as low as 1%. In practice, this means that if the clients of a particular bank have deposited, say, a total of one million dollars, that bank can immediately use at least 90%, or $900,000, of these deposits in issuing interest-bearing loans.
Even more amazingly, they now commonly issue these loans not only on the actual deposits that they have received, but also on the basis of mortgage agreements where there is merely a promise on the part of the mortgagee to pay a certain sum to the bank over a fixed period of time. So, for example, suppose that you get a mortgage of $100,000 from a bank to buy a house. On the basis of this purely paper transaction, the bank credits itself with $100,000, 90% of which it can then legally issue in the form of additional interest-bearing loans to other clients. Critics of this astonishing process commonly call it “creating money out of thin air.”
Fiat Currency–The Fatal Financial Mutation
This background puts us in position to understand the potentially fatal flaw of fiat money and how it has historically led to hyperinflation and the collapse of a vast number of national economies.
The Latin word, “fiat,” literally means “let it be done” or “by decree”. “Fiat currency,” then, is actually a form of currency that has no intrinsic value and also is not backed by anything of value; rather it is simply decreed by governmental fiat to be “legal tender.”
For this reason, it is sometimes referred to disparagingly as “toilet paper money.”
Just as is true of individual humans, national governments have a strong and unfortunate propensity to spend beyond their means. This is especially true when they go to war-which, tragically, they do quite repetitively. As a result of this over-spending, they commonly incur huge amounts of debt. Then, in order to avoid bankruptcy, they create fiat currency-or what is often called “making money out of thin air.” If an individual citizen of a country were to do this, it would simply be called “counterfeiting.”
When governments create fiat currency more rapidly than what is produced through their economic growth, some inevitable and unfortunate consequences occur. Most immediately, it lowers the value of each monetary unit. As this happens, progressively more of these units are thus required to purchase consumer goods. This is called inflation. As the supply of fiat currency is inflated, prices are inflated accordingly. This excess “money” progressively dilutes the value of ALL money in the system.
Gradually-or sometimes very suddenly-this can (and does) lead to hyper- or runaway inflation. When this occurs, ordinary citizens are unable to afford even the most essential goods, because of their exorbitant prices. Moreover, the financial assets of the vast majority of citizens suddenly plummet in value and may literally be wiped out overnight. It takes relatively little imagination, then, to understand how this tragic and progressive scenario can readily lead to the complete collapse of a nation’s economy.
In a follow-up article, I will provide specific examples of how this has occurred with numerous countries over the past century.