The Ultimate Failure of Fiat Currencies

A look at the failures of fiat currencies and why they failed including Rome’s Denarius, China’s flying cash, France’s Franc, and Germany’s Mark,

The Ultimate Failure of Fiat Currencies

Traders once again waited for the Fed to print more money, only to be disappointed.

The TSX had its biggest one-day drop in 2012.

Moody’s just downgraded a bunch of major global financial institutions, including Royal Bank of Canada, Bank of America Corp., Citigroup Inc. Goldman Sachs and JP Morgan Chase, as well as Barclays, Deutsche Bank and Societe Generale.

The downgrade was political. A simple fact to tell the world it’s time to print more money.

After a few weeks of moving up the markets are once again tanking. I already mentioned this many times in past letters: the faster the markets move up with little volume, the faster it will come down.

The recovery will be slow. Worldwide financial crisis exists. The world is deleveraging. It’s that simple.

Why won’t people learn?

Every time the Fed has been expected to print, they haven’t. Instead, they once again announced they would extend operation twist*; but only until the end of the year and by an amount less than expected.

(*Operation twist is a fancy term for selling short-term securities to buy longer-term ones to keep long-term borrowing costs down.)

While no QE was announced this time, traders are still looking forward to the next meeting for the Fed to do more.

Eventually the Fed will print.

Trouble Ahead?

As if there already wasn’t enough trouble at home, the European debt crisis continues with no real solution; further dampening U.S. economic activity and employment.

The Fed once again slashed its estimates for U.S. economic growth this year to a range of 1.9 percent to 2.4 percent, down from an April projection of 2.4 percent to 2.9 percent. It also cut forecasts for both 2013 and 2014. Officials also said they expect the job market to make slower progress than they did just a couple months ago, but unemployment rate will remain at 8 percent or higher for the rest of this year.

By his own words, Bernanke has already told us they will do more: “If we are not seeing sustained improvement in the labor market that would require additional action,” he said. “We still do have considerable scope to do more and we are prepared to do more.”

Not only do they expect little to no improvement in the labour markets, they also see it getting worse. That means additional action will eventually be taken; but not until we suffer some more.

As I mentioned a few weeks back in “Uh oh, Look Out,” every fiat currency since the Romans first began the practice in the first century has not only ended in devaluation but eventually in collapse.

Not only did currencies fail, but the economies that housed them failed as well.

The Ultimate Failure of Fiat Currencies 

Rome: The Denarius

While Rome didn’t actually have paper money, it was the earliest known currency that failed as a result of debasement.

The Denarius was a coin made of silver but its value, when created, was higher than that of its silver content. Like most currencies it was created in mass quantities to fund war efforts.

When introduced, the denarius contained nearly pure silver at a theoretical weight of approximately 4.5 grams. But by the time it was finished, the coins contained practically no silver at all.

As a result, other currencies were created; the antoninianus was one of them. Although nominally valued at two denarii, the antoninianus never contained more than 1.6 times the amount of silver of the denarius. As the number of antoniniani minted increased, the number of denarii minted decreased, until the denarius ceased to be minted in significant quantities by the middle of the third century.

The second half of the third century was rife with war and uncertainty. More antoniniani was created to fund war efforts and the silver content of the antonianus eventually fell to only 2%, almost losing the appearance of being silver.

The decline in the silver content to the point where coins contained virtually no silver at all finally caught up. As a result, it was countered by the monetary reform of Aurelian in 274. The standard for silver in the antonianus was then set at twenty parts copper to one part silver, and the coins were noticeably marked as containing that amount.

Despite the reform of Aurelian, silver content continued to decline – until the monetary reform of Diocletian. In addition to establishing the tetrarchy, Diocletian devised the following system of denominations: an aureus struck at the standard of 60 to the pound, a new silver coin struck at the old Neronian standard known as the argentous, and a new large bronze coin that contained two percent silver.

However, none of these currencies lasted as a result of debasement due to inflation, war, and poorly managed state finances. There weren’t enough precious metals to go around and every coin was debased to increase the amount that the government could spend; allowing the states to spend more than it had. By decreasing the amount of silver in their coins, Rome could produce more coins and “stretch” their budget.

Every currency created to replace one that was over produced failed for the same reasons – over and over again.

This same scenario has repeated in itself all over the world for thousands of years.

The Chinese

The Chinese were one of the first to use paper money. And for a while it worked. But like all fiat currency, eventual debasement and inflation would lead to its failure.

From the Silk Road Foundation:

Paper money began with the “flying cash” of the Tang (618-907) dynasty around 800. The Tang government considering the inconvenience of shipping cash to distant areas where government purchases were made, paid local merchants with money certificates called “flying cash”, because of its tendency to blow away. These certificates bearing different amounts of money could be converted into hard cash on demand at the capital. Since they were transferable, they were exchanged among merchants almost like currency.

“Flying cash” was not meant to be currency and its circulation was rather limited. Real paper currency was not introduced until early in the Song (960-1279) dynasty, when it was utilized by a group of rich merchants and financiers in Szechuan, the same province where the art of printing had been invented. These banknotes, which were hard to counterfeit, could be converted into hard cash at any time in any of the issuing banks. Widely circulated, they were readily accepted for the payment in debt and other financial obligations.

In 1023 these banknotes were eventually withdrawn and only official notes printed by the government were allowed. This new adopted governmental policy was successful at first for two reasons: First, for each issue of paper notes to be put into circulation, the government provided cash backing. Second, paper notes and standard coins were interchangeable. Moreover, a citizen could buy salt or liquor with his paper notes from the government-owned stores. In short, paper notes were as good as coined money.

But it was still only backed by a promise by the government…

After Chin (1115-1234) occupied the north China, it followed Song’s practice. In 1154 it established a Bureau of Paper Currency in Kaifeng as the central agency in charge of all issues. Paper currency was issued but inflation soared during the 12th century.
Again, it was a result of over printing.

Soon after the Mongols took over China and established the Yuan (1264-1368) dynasty, it followed the example of its predecessors, Tang, Song and Chin, in using paper currency. The first paper currency issued in Yuan dynasty was in 1260. Excessive printing year after year soon flooded the market with depreciated paper money until the face value of each certificate bore no relation whatsoever to its counterpart in silver coin.

In 1272 a series of new issues was put in circulation and the old issues were converted into the new ones at the ratio of five to one. The new issues were printed with copper plates instead of wood blocks, as had been the case before. In 1309 another conversion became necessary.

Again, as a result of over printing the currency.

From 1260 to 1309 Yuan’s paper money was depreciated by 1000 percent.

(The dollar has depreciated by 661% in the last 50 years and by 2
221% in the last century)

To make the situation worse, the government often refused to exchange for old certificates that had been worn out for new issues.

Like the Romans, new currency was created to replace old ones; until they all ended in failure.

The French

The French had many attempts at fiat currency; they too all failed miserably.

The first French paper money was issued in 1701 and was denominated in livres tournois. However, the notes did not hold their value relative to silver due to massive over-production. The Banque Royale (the last issuer of these early notes) crashed in 1720, rendering the banknotes worthless. Lehman Brothers, anyone?

In 1726 under Louis XV’s minister Cardinal Fleury, a system of monetary stability was put in place. Eight ounces (a mark) of gold was worth 740 livres, 9 sols; 8 ounces of silver was worth 51 livres, 2 sols, 3 deniers. This led to a strict conversion rate between gold and silver (14.51 to 1).

Later, a kind of paper money was reintroduced by the Caisse d’Escompte in 1776 as actions au porteur, denominated in livres. These were issued until 1793, alongside assignats from 1789.

Assignats were paper money issued by the National Assembly in France from 1789 to 1796, during the French Revolution. The assignats were issued after the confiscation of church properties in 1790 because the government was bankrupt. The government thought that the financial problems could be solved by printing certificates representing the value of church properties. These church lands became known as biens nationaux (“national goods”).

Assignats were used to successfully retire a significant portion of the national debt as they were accepted as legitimate payment by domestic and international creditors. Originally meant as bonds, they evolved into a currency used as legal tender.

As there was no control over the amount to be printed, the value of the assignats exceeded that of the confiscated properties. This caused massive hyperinflation. In the beginning of 1792, they had lost most of their nominal value. In 1796, the Directoire issued Mandats, a currency in the form of land warrants to replace the assignats, although these too quickly failed.

(source Wikipedia)

See a pattern yet?

This hyperinflation was stirred up by repeated food shortages. Instead of solving the financial problems, the assignats became a catalyst for (food) riots. Instability continued after the abolition of the monarchy, exacerbated by the wars France faced. This situation impeded the implementation of good financial policies that would reduce debts. As a result, the Maximum Price Act of 1793 aimed to regulate inflation.

When the Directoire came into power in 1795, the Maximum Price Act was lifted and hyperinflation re-emerged. In the next four years Paris was the stage of yet more riots.

The inflation was finally solved by Napoleon in 1803 by introducing the franc as the new currency. By this time, the assignats were basically worthless.

In 1800 the Banque de France, a federal establishment with a private board of executives, was created and commissioned to produce the national currency.

In 1803, the Franc germinal (named after the month Germinal in the revolutionary calendar) was established, creating a gold franc containing 290.32 mg of fine gold. From this point, gold and silver-based units circulated interchangeably on the basis of a 1:15.5 ratio between the values of the two metals (bimetallism) until 1864, when all silver coins except the 5 franc piece were debased from 90% to 83.5% silver without the weights changing.

This currency system was retained during the Bourbon Restoration and perpetuated until 1914.
France was a founding member of the Latin Monetary Union (LMU) in 1865. In 1873, the LMU went over to a purely gold standard of 1 franc = 0.290322581g gold.

The outbreak of World War I caused France to leave the gold standard of the LMU. The war severely undermined the franc’s strength: war expenditure, inflation and postwar reconstruction, financed by printing ever more money, reduced the franc’s purchasing power by 70% between 1915 and 1920; and by a further 43% between 1922 and 1926. After a brief return to the gold standard between 1928 and 1936, the currency was allowed to resume its slide. By 1959 it was worth less than 2.5% of its 1934 value.

World War II

After World War II France devalued its currency within the Bretton Woods system on several occasions.

Beginning in 1945 at a rate of 480 francs to the British pound (119.1 to the U.S. dollar), by 1949 the rate was 980 to the pound (350 to the dollar). This was reduced further in 1957 and 1958, reaching 1382.3 to the pound (493.7 to the dollar, equivalent to 1 franc = 1.8 mg pure gold).

New franc

In January 1960 the French franc was revalued at 100 existing francs. Old one- and two-franc pieces continued to circulate as centimes with 100 of them making a nouveau franc (the abbreviation “NF” was used on the 1958 design banknotes until 1963).

Inflation continued to erode the currency’s value, but much more slowly than that of some other countries. Nonetheless, when the Euro replaced the franc in January 1999, the franc was worth less than an eighth of its original 1960 value.

Eventually all franc coins and banknotes ceased to be legal tender in January 2002, upon the official adoption of the euro.

The Germans

The first mark, known as the Goldmark, was introduced in 1873. With the outbreak of World War I, the mark was taken off the gold standard, as with many currencies around the world.

The currency thus became known as the Papiermark, especially as high inflation, then hyperinflation occurred and the currency became exclusively made up of paper money.

Once again, this massive printing of money was a result of the German government’s decision to pay its war debt by printing banknotes backed by nothing more than a promise by the same government that printed them.

From 1914, the value of the Mark fell. The rate of inflation rose following the end of World War I and reached its highest point in October 1923. This was a period of insane inflation where banknotes literally became worthless paper that some even used to heat their furnace.

When a Trillion is Worthless

The value of the mark relative to the gold-backed dollar plummeted from 8-to-1 right after the war to 4.2 trillion-to-1 in 1923. Even the American penny was valued at 42 billion marks. By late 1923 the Weimar Republic of Germany was issuing two-trillion Mark banknotes and postage stamps with a face value of fifty billion Mark. The highest value banknote issued by the Weimar government’s Reichsbank had a face value of 100 trillion Mark (100,000,000,000,000; 100 million million).

The Others

History will show that every fiat currency that existed eventually failed and/or has become worthless.

The largest denomination banknote ever officially issued for circulation was in 1946 by the Hungarian National Bank for the amount of 100 quintillion pengő; that’s an insane 100,000,000,000,000,000,000!

The Post-World War II hyperinflation of Hungary held the record for the most extreme monthly inflation rate ever – 41,900,000,000,000,000% (4.19 × 1016% or 41.9 quadrillion percent) for July 1946, amounting to prices doubling every 15.3 hours. By comparison, recent figures (as of 14 November 2008) estimate Zimbabwe’s annual inflation rate at 89.7 sextillion (1021) percent, which corresponds to a monthly rate of 5473%, and a doubling time of about five days. In figures, that is 89,700,000,000,000,000,000,000% annually. <br
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The largest Zimbabwean dollar banknote issued was an astounding 100,000,000,000,000 – the greatest number of zeros shown on any bank note (the pengő had spelled out their worth as opposed to actually writing the number on it.)

What about the Americans?

The Americans

During the American Revolution the colonies became independent states. Freed from British monetary regulations they issued paper money to pay for military expenses. The Continental Congress also issued paper money during the Revolution, known as Continental currency, to fund the war effort.

By the end of the war, both the state and Continental currency becoming practically worthless as a result of too much printing and counterfeiting.

The Continental currency was issued in 1775. In three years, Continentals retained less than 20% of their face value. Five years after they were issued, the bills were worth just 2.5% of face value. By May 1781, just six years later, Continentals had become so worthless that they ceased to circulate as money.

The inflation and collapse of the Continental dollar prompted the delegates to the Constitutional Convention to include the gold and silver clause into the United States Constitution so that the individual states could not issue bills of credit, or “make any Thing but gold and silver Coin a Tender in Payment of Debts.”

If you purchased an item in 1913 for $20, that same item would now cost you $464.27; that’s equal to an annual inflation rate of 2221.4%.

Where True Wealth Lies

Despite past experiences, human society is once again repeating the doomed failure of paper currency. The world is printing more money than it ever has and the Fed dollar is less than 50 years old. How long will it survive?

While it could continue to last for many years to come – being the world’s reserve currency – its purchasing power is clearly diminishing as inflation is well above 4% in the US. This number will only grow as the Fed continues to print – which it will.

Like everything else paper money has its cycles. Where do you think the dollar is in its cycle? Banks are failing, money continues to be printed, debts are at an all-time high, and some of the strongest countries in the world remain in a financial crisis; of which many own US currency.

The only thing that has kept its value in history is gold. Purchasing power not only remains consistent with gold but has risen against all other world currencies. History teaches us many things; it teaches us that those who ignore history are bound to repeat it.

If history is any indication of our future, we’re awfully close to repeating it.

But there is a bright side no one talks about.

Despite being worthless years ago, the US Continentals are actually worth a lot now – as collector pieces for what once was and never will be.

If you’re into collector items, perhaps saving your dollars might not be such a bad idea. Once it becomes worthless, it’ll be worth a lot…

The same scenario of an ever-increasing money supply has repeated itself all over the world for thousands of years. What’s so different now? This is the ultimate failure of fiat currencies.

Where’s your paper?

Until next week,

Ivan Lo

Equedia Weekly

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