The Evolution of Monetary Systems: From Hard Money to Fiat Money
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For thousands of years, there have always been three types of monetary systems: Type 1: Hard money (e.g., metal coins), Type 2: Paper money (claims on hard money) and Type 3: Fiat money. Hard money is the most restrictive system because money can’t be created unless the supply of the metal or other intrinsically valuable commodity that is the money is increased. Money and credit are more easily created in the second type of system, so the ratio of the claims on hard money to the actual hard money held rises… The result is a) defaults, when the bank closes its doors and depositors lose their hard assets, and/or b) devaluations of the claims on money, which mean depositors get back less.
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In the third type of system, governments can create money and credit freely… So when the system of hard money and claims on hard money becomes too painfully constrictive, governments typically abandon it in favor of what is called “fiat money.” No hard money is involved in fiat systems; there is just paper money that the central bank can print without restriction. As a result, there is no risk that the central bank will have its stash of hard money drawn down and have to default on its promises to deliver it. Rather, the risk is that, freed from the constraints on the supply of tangible gold, silver, or some other hard asset, the people who control the printing presses (i.e., the central bankers working with the commercial bankers) will create ever more money and debt assets and liabilities in relation to the amount of goods and services being produced until the time comes when those holding the enormous amount of debt will try to turn it in for goods and services, which will […] result in either debt defaults or the devaluation of money.
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When a country needs more money and credit than it currently has, whether to deal with debts, wars, or other problems, it naturally moves from Type 1 to Type 2, or Type 2 to Type 3, so that it has more flexibility to print money. Then creating too much money and debt depreciates their value, causing people to get out of holding debt and money as a storehold of wealth and move back into hard assets (like gold and silver) and other currencies. Since this typically takes place when there is wealth conflict and sometimes war, there is also typically a desire to get out of the country. Such countries need to re-establish confidence in their currency as a store hold of wealth before they can restore their credit markets.
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… This ‘big cycle’ typically plays out over something like 50 to 75 years; its ending is characterized by a restructuring of debts and the monetary system itself. The abrupt parts of these restructurings—i.e., the periods of debt and currency crisis—typically happen quickly, lasting only a few months to up to three years, depending on how long it takes the government to act. However, their ripple effects can be long-lasting…
