Subjective value and currencies

“The issuer’s promise” is a phrase I have used recently to describe the backing for fiat currencies. The purpose of this article is to define it further, given that it is increasingly likely to be challenged in the foreign exchange markets with respect to the euro.

To begin we need to define the principal difference between gold and a fiat currency. Gold has no price when it is used as money, other than what it is exchanged for in goods. Uniquely as money, it was in demand everywhere by all societies to settle their own domestic and foreign trade. Fiat money is only used to settle transactions in the jurisdiction to which it relates, and foreigners who end up with it exchange it for their own fiat money, because out of jurisdiction it is not money.

There are three basic exceptions to this rule. The dollar, through its original gold convertibility became a substitute for gold, and still enjoys an international role as a result of that legacy. A second exception is when governments intervene and build up holdings of foreign fiat money. And the third is when ownership of foreign currencies accumulates for speculative purposes. Otherwise, outside its jurisdiction a fiat currency has no useful value.

Its validity is based on a promise by the issuing central bank and the relevant government that it actually has value. The value of that promise is subjectively assessed in foreign exchange markets, where dealers compare fiat currencies. The result is that the purchasing power of a fiat currency can diminish substantially in foreign exchanges before disrupting its domestic monetary role. The dollar, for example, has lost most of its purchasing power since it became completely disconnected from gold in 1971, but Americans still think automatically “I have 10 bucks to spend: what shall I buy?” rather than “I must get rid of these 10 bucks before they lose yet more value”.

We all think like that with our respective fiat currencies, and the moment we don’t marks the start of a collapse in confidence in the issuer’s promise. This could be the euro’s Achilles Heel, because there is no identifiable government actually prepared to stand behind the European Central Bank, and as the crisis intensifies, there is a growing risk the promise will be found wanting by the eurozone’s own citizens.

Fiat money is managed by neoclassical economists at central banks who think they understand price theory. The euro is in danger of a sudden collapse, and it is not clear that the powers-that-be in the ECB understand this. It is not even clear if they understand that hyperinflation is not, as the term in modern usage suggests, an accelerating rise in the price of goods. Instead it is a collapse in the value of fiat money that arises from a reassessment of the issuer’s promise by domestic users.

The euro’s future is essentially tied to a collection of disparate governments. If any of them leaves, it risks bringing on a collapse in its value that is completely beyond the control of the ECB.

This article was previously published at

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6 replies on “Subjective value and currencies”
  1. says: mrg

    “Its validity is based on a promise by the issuing central bank and the relevant government that it actually has value.”

    I’m afraid this still doesn’t make any sense to me.

    What exactly is the promise? Why does the government have anything to do with the matter (except to the extent that they have influence over the central bank)?

    “there is no identifiable government actually prepared to stand behind the European Central Bank”

    Can you give an example of the sort of action a government could take to ‘stand behind’ a central bank?

    ISTM that all political pressure is in the direction of destroying paper money, rather than preserving it.

    In that respect, the “collection of disparate governments” meddling with the euro seems preferable to our ‘identifiable’ government in Westminster intent on debasing the pound.

  2. says: Paul Marks

    All ECONOMIC value is indeed subjective.

    Gold and silver (like all commodities) have their uses, but if people choose to do without the things that gold and silver make then (if all people everywhere made the same choice), gold and silver would lose their value.

    However, this does not save fiat money – for its value is based on FORCE AND FEAR.

    The legal tender laws, and the demands by governments that their taxes are paid in this fiat money.

    As has been known for thousands of years, even the death penality can not prevent fiat currency (such as debased coinage or paper notes) falling in value (in relation to what it would have been) as its quanity is increased by government (or by government backed entities).

    Politicians think they have created the philosopher’s stone with fiat money – a way of financing their spending without taxing people into the ground.

    But they have not – for the costs still hit in THIS ERA (not future generations), the resources the fiat money (whether notes or computer credit) divert from productive uses (in order to finance government – and anyone who thinks government spending is “productive” should read Bastiat) still undermines economic life.

    Whether financed by taxation or by fiat money (including by government backed credit bubble banks), the Welfare State will still lead to economic collapse.

    An unwise fiscal policy (i.e. spend, spend, spend) can NOT be saved by an “expansionary” monetary policy.

    And government claims of “austerity” are lies.

    As for mrg’s claim that the Euro is preferable to the Pound.

    I am afraid this “does not make sense to me”.

    Experience has already proved that the supposed legal restrictions on the Euro Central Bank are meaningless. TRILLIONS of extra Euros have been created by the Euro Central Bank.

    It may be no worse than the Bank of England, Federal Reserve …. (and on and on), but it is no better either.

    A fiat money system is a bad system – whether it is being run from London, Washington or Frankfurt (or anywhere else).

  3. Except of course, no one will leave. This entire exercise, I suspect, is under very careful macro management. This is about stripping the Assets from Citizens. This is about a ‘convenient crisis’ which lead to the weaker Nations becoming the Vassals of the strongest Nation. I am convinced the Euro will reach parity with the USD and there will be an Export led recovery. Where will the Exports go to? Developing Nations who will be driven into borrowing New debt ….
    The periphery nations will be the low wage unskilled factory and a healthy (not) dose of Inflation in the ‘richer’ (cough) Nations will eat the Debts away, together with Haircuts left, right and centre. Welcome to the ‘Planned Economy’, what the Soviets never managed to pull off quite right, Brussels will do.

    1. says: Paul Marks

      The “export led recovery” has already happened – German companes selling machine tools (and so on) to Chinese companies, and companies in other countries (such as India).

      India is running into increasing problems (the government there can not afford its promises).

      China is a mystery to me – but demand for new goods (from Germany and so on) is certainly not going to increase, it is going to FALL.

      2013 is going to be an economic nightmare – and 2014 is going to be worse.

      Whoever is elected in the United States.

  4. says: Craig Howard

    ” if people choose to do without the things that gold and silver make then (if all people everywhere made the same choice), gold and silver would lose their value.”

    They might lose some of their value [silver more than gold because its industrial uses are greater,] but gold wouldn’t lose much value at all. Gold is not selling at $1600 an ounce because of the things made from it.

    Other than bars, of course.

    1. says: Paul Marks

      I was including the bars (and the coins) under the word “things” Mr Howard.

      Which, yes I admit, is cheating.

      However, the point is still valid.

      If, for example, a weird cult swept the world (all of it – everyone) holding that gold coins and bars were worthless – then they would indeed be worthless.

      Of course that is not very likely……

      For practical purposes (leaving aside theoretical concerns) gold is indeed the least worst place to put your money (although only as a long term insurance plan – NOT for speculation, no buying on margin or other nonsense please).

      As Glenn Beck (the best gold salesman because, like all the best salesmen for any good or service, he honestly believes in the product himself) is fond of saying….

      “If gold ever loses its basic value, what will be of value is lead”.

      I hope I not need to explain.

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