[2237] Of why I prefer fiat currency to commodity-backed currency

Libertarians generally are in favor of commodity-backed currency. This is largely based on typical libertarian attitude towards the state: do not trust them.

Others who are not quite libertarian share the same idea about trust. They really have trouble believing that a piece of paper worth something when it is only backed by some promise. They rather have a piece of paper that essentially put a claim on some asset. Typically, that asset is gold although it does not have to be gold.

A step beyond the issue of trust is the fear of inflation and the belief that commodity-backed currency is not inflationary. It is a myth that commodity-backed currency is not inflationary however. Theoretically, gold supply can increase to affect the quantity of money in the economy directly and thus, creating an inflationary environment. Admittedly, there is more inflationary risk associated with fiat currency than to commodity-backed currency.

Before we go farther down the road, let me clarify one thing: I do not think highly of commodity-backed currency when it is juxtaposed with fiat currency.

As a libertarian, I need to rationalize my position through libertarian means, especially so when I am going against the libertarian stream. This entry is partly where I do that rationalization.

I would like to address the worry of inflation first because it is more general than specific libertarian concern. I will visit the libertarian concern soon after.

The inflationary concern has been overblown by proponents of commodity-backed currency, and especially by supporters of gold standard. Despite the ”˜distrust-the-government’ mantra, modern monetary institutions these days are good at managing inflation. The occurrence of hyperinflation, which is really the problem, is rare. As long as those institutions are independent under normal everyday circumstances, inflation can be contained, or at least inflation attributable to changes in money supply. Note that not all inflation is due to increase in money supply.

On the issue of libertarian distrust of government, that does not really automatically translate into support for commodity-backed currency or more specifically, for gold standard. Private banks, for instance, can issue fiat currency. The only prerequisite to fiat currency is trust, no matter who the issuer is.

But what about trust in general, be the issuer is the government or some private entities? I would like to argue the use of commodity-currency is a society that suffers from trust deficit. I will save that for another day.

Finally, the practical reasons for fiat currency vis-à-vis commodity-backed one are unrivaled. One of those major reasons is flexibility: I value the flexibility that comes with fiat currency, which commodity-backed currency does not have. The flexibility is this: fiat currency can completely mimic commodity-backed ones while the reverse is untrue.

Flexibility is especially valuable in times of economic crisis. Perhaps, once I find myself in an economic foxhole, I tend to waver on the idea of limited government. But I would like to think that the flexibility of monetary policy allows the use of monetary policy as the first course of action when the other option is fiscal policy. I think this is a practical libertarian justification to the use of fiat currency.

Fiscal policy is more damaging to the idea of laissez-faire than monetary policy. Fiscal policy tend to have real programs associated with it while monetary policy is just, well, about money. Programs associated with fiscal policy often involve active government intervention in multiple fields. Meanwhile, the management of money involves only passive intervention. Between the two evils, I would vote for monetary policy. I am voting for monetary policy.

But that choice is available only when there is flexibility in the monetary policy. Without flexibility, the urge to engage on large fiscal policy can be too great to resist in time of crisis.

People do not like pain. In a democracy, doing nothing may not be viable. The democratic reality is that there is a populist element needs to be tended to, however unfortunate that is. With monetary policy, at least there is an avenue to do something and reduce the pressure for heavy government intervention.

Of course, both policies are not mutually exclusive but with monetary policy, the size of fiscal policy can be managed, compared to a scenario where there is limited monetary policy spectrum to choose from, i.e. when there is only commodity money.