Paper money backed only by credulity marks its 40th anniversary this week. But as the world endures yet more economic turmoil, and the European Central Bank prepares a team for the money printing Olympics in Washington DC, celebrations should be subdued.
In August 1971 President Nixon, and the world, shook off the last vestiges of the gold standard, which had underpinned the world's peacetime monetary system for centuries. No longer would the American authorities exchange gold for dollars at a fixed rate per ounce, as they had since 1833.
For Nixon, ending the gold standard was an expedient: the costs of the Vietnam War and President Johnson's 'Great Society' had undermined faith in the American dollar. Foreign central banks had been swapping their US dollars for gold as fast as they could.
But economists were cheering: abolishing the gold standard brought great benefits. Gold was freed up for alternative uses and, as Paul Samuelson put it in 1970, "how absurd to waste resources digging up gold only to inter it in Fort Knox".
Moreover, the gold standard, a "barbarous relic" for Lord Keynes, prevented governments from 'managing' the economy. Along with Nixon, we were all Keynesian now: expert bureaucrats would guide the money supply, interest rates and government budgets. Rational practitioners of the dismal science would tame inflation and unemployment. It was a new dawn.
Surveying the past 40 years, though, it is not clear that fiat money has fostered price stability or lower unemployment, in Australia or anywhere else.
Fiat currencies serve as a medium of exchange and unit of account, two of the core requirements of money, but they are a woeful store of value, the third. Australian prices, for instance, have increased over 800% since 1971. Even today, with inflation 'under control', Australian prices will go up this year as much as US prices did in 34 years from 1880, when US annual inflation averaged 0.1% and the world observed a gold standard.
And, far from guiding wisely, central banks in the United States and Europe fanned the financial crisis. Artificially low real interest rates subsidised asset bubbles, emboldened bloated banks and distorted the economy toward debt-fuelled consumption. People put their life savings in shares to escape the inexorable inflation, only to chain their confidence to what used to be the remote gyrations of the bourse.
It was a false dawn; economists forgot about politics. As George Bernard Shaw put it, if "you have to choose between trusting the natural stability of gold and ... the honesty and intelligence of [bureaucrats and politicians] I advise you... to vote for gold". He appears to have had a point: gold hit $1,800 an ounce last week, a fifty-fold increase from 1971. All currencies have collapsed against gold.
If fiat currencies facilitated the global financial crisis of 2008, they provoked the US and European debt crises, casting a pall over the world economy. Fiat currency has been the biggest moral hazard of all time, encouraging governments to borrow and spend beyond their natural limits in full knowledge they could always repay their debts. After all, even the crazy French 1st Republic repaid its debts: in worthless assignats.
Rampant money creation in the United States and Europe, politely known as 'quantitative easing', is having little impact on job creation. Unemployment still hovers above 9% on both sides of the Atlantic. But it will surely ease the debt burden of governments. As a 40-year-old Alan Greenspan wrote in 1966 (somewhat ironically given his later career):"In the absence of the gold standard, there is no way to protect savings from confiscation through inflation."
Inflation is an insidious tax that impoverishes poor workers, whose wages are not indexed and whose savings are in bank deposits, the most. It discourages saving, makes long-term planning almost impossible, and sucks up resources into avoiding, forecasting and profiting from inflation – socially unnecessary and useless tasks. Inflation demotes genuine entrepreneurship.