style="font-size:15px;"> They soon begin surveying the island in search of food, water, and shelter. Bill soon discovers a fruit tree and immediately lays claim to it. Joe, who is literally starving, begs his brother Bill for a piece of fruit. Under normal circumstances, Bill would accept money as payment for his newfound treasure trove. But what good is paper currency on this island?
After he realizes that no amount of begging will work on his stingy brother, Joe devises a plan. In his pocket, Joe has eight golf balls. He approaches Bill with the idea of using the eight golf balls as the island’s new official currency. Bill agrees and under their new “currency” system, both men receive four golf balls with which to trade for things that the other man may find.
Finally, Joe, who is famished and desperate for food, offers Bill one of his golf balls for a piece of fruit from Bill’s tree. Bill considers it a fair trade. Suddenly, as the two men are finalizing their transaction, a very loud noise, like something striking the ground, is heard just a few hundred feet away. Eager to see what has caused the noise, Joe and Bill run to investigate. What they discover shocks them both. Right there on the white sandy beach in front of them lays a very large wooden crate attached to a parachute. The outside of the box reads: “Golf Balls — 100,000 count.”
Now considering what we have learned so far, what effect do you think this new box containing 100,000 golf balls is going to have upon the price of the piece of fruit that Joe wants to buy?
Answer: The price of Bill’s fruit will go up dramatically. And the price increase happens instantaneously as the available money supply on the island (golf balls) has suddenly increased from 8 to just over 100,000 in a few brief moments! Given this dramatic increase in the money supply, do you think that Bill is still willing to accept just 1 golf ball for his precious fruit? Why not 50 or 100? Or even 1,000?
Interestingly, Bill could not ask for more than 8 golf balls for his fruit prior to the discovery of the 100,000 golf balls. And yet, just moments after the discovery of the golf balls, his price could rise immediately.
This above illustration provides a classic example of the effects that changes in the money supply have on prices within an economy. This is the definition of inflation: an increase in the money supply. Inflation is basically a hidden tax on consumers and will be discussed in further detail in our next chapter. Of course, the government and their paid economists prefer to define inflation as an increase in the prices within the economy. However, price increases are only a symptom of the increasing money supply. The reason why governments prefer to define inflation as an increase in prices and not in the money supply is simple. If inflation is simply an increase in prices, then how can anyone blame the government? Instead, we should blame those greedy capitalists and businesses who are always trying to raise prices. Don’t be fooled. Inflation is an increase in the money supply. The only one to blame is the government and their central banking scheme.
At its most rudimentary level, our current monetary system shares many similarities with our golf ball illustration. In essence, the more scarce the money supply, the lower the price of the goods and services denominated in that currency. The opposite is also true. The more abundant the money supply, the higher the prices will be for the same goods and services. This is because the amount of money within any economy is directly related to, and has a direct effect upon, the prices within that economic system.
Is milk more expensive? If so, either the dairy business is passing on its higher costs to consumers, or more currency has been pumped into the economy.
Has bread become more expensive than it used to be? Either the costs of making bread have gone up, or the government is allowing more currency to be injected into the economy.
Therefore, if the price of everything seems to be going up within a particular economy, ask this question: Is the government increasing the supply of money within the system? In our modern era, the answer is almost always yes, regardless of where you live.
When an increase in a nation’s money supply, or inflation, becomes uncontrollable, it is called hyperinflation. Hyperinflation is one of the most dangerous economic problems that can confront a nation as it causes dramatic price increases which eventually cripple the underlying economy. Unfortunately, hyperinflation has been at the root of nearly every fiat currency system collapse in history.
A Brief History of Fiat Currencies
Let us now examine several nations that have resorted to the use of fiat currencies throughout history. While all of these experiments with paper currency ended in disaster, let them serve as a testimony and reminder to mankind’s tendency toward greed, coupled with his embarrassing inability to rule himself.
Ancient Rome
Our brief journey through the history of fiat money begins in the time of ancient Rome. The story of the rise and fall of the Roman Empire offers a wealth of insights. And while the empire’s rise was due to a variety of interesting factors, the reasons for its fall are rather predictable and historically identifiable: significant government overspending, financial greed, an entitlement mentality, and military overextension.
Obviously, the colossal costs of financing the empire’s perpetual state of war, plus its numerous public works projects and entitlement programs, required ever-increasing tax revenues. Over time, many could not bear the increasing tax burden and sought relief through tax evasion. As many sought financial relief by opting to evade their taxes, the empire’s revenues consistently fell short. Instead of making draconian spending cuts, the empire moved to create a stealth tax that no one could hide from: inflation. (As history will demonstrate, a shortfall in government revenue rarely leads to meaningful cuts in public spending.)
While Rome did not use paper money, the empire still provides one of the first pure examples of currency debasement in history. The official currency of the Roman Empire was the denarius, a metal coin composed of 100 percent pure silver. The pure silver content of the Roman denarius remained intact until Emperor Nero came to power. In a.d. 64, Rome suffered a great fire, which required a massive urban rebuilding effort. The immense rebuilding costs required more money than the Roman treasury held in reserves. In order to raise adequate funding for the reconstruction, Nero exacted higher tax revenues from Rome’s provinces.
But Nero did not stop there. In an effort to raise even more money, the maniacal emperor intimidated coin makers at the mint to dilute the silver content in the denarius. To accomplish this, the silver content of the empire’s silver coins was melted down and replaced partially with iron or copper. Similarly, the empire’s gold coins were diluted and partially replaced with copper. Because the dilution of the silver and gold coin content was done in limited amounts, few citizens noticed the new hybrid coins.
As the empire’s financial needs grew, cheaper metals like copper and tin began to replace the gold and silver coins that had once been the empire’s currency. Using these cheaper metals meant that more currency could be produced and the money supply could be artificially expanded. The inflationary pressures caused by the increased supply of currency naturally led to higher prices within the Empire.
In a.d. 301, Emperor Diocletian sought to end the increasing prices through price controls. By issuing the Edict of Prices, Diocletian threatened any and all merchants with the death penalty if their prices went above Rome’s acceptable range.
Through the debasement of the Empire’s currency, the government leaders were able to raise large sums of new money for their pet projects. However, Rome’s flirtation with currency debasement became an obsession. By the end of the Roman Empire, a denarius coin was approximately .02 percent silver and 99.98 percent iron! As the Roman currency continued declining in value, merchants and laborers alike shunned its use.7 The Empire’s failed economic
