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Trust

20–21 October 2012

Wikipedia

In Wikipedia, the Dutch article about fiduciair geld (English: fiduciary money) is linked to the English language article about fiat money (also called: fiat currency).

This suggests that fiduciary money and fiat money are the same thing. In practice, effectively, they are. But when you look at the meaning of the words, the ideas are very different.

End of Bretton Woods

Until the Nixon Shock, there was a fixed ratio between dollars and gold. The gold price was 35 US dollars per ounce of gold. (It didn’t mean however, that the Fed was required to always exchange dollars for gold, according to this explanation.)

If we compare that gold price of 35 dollars to today’s (over 1,700 dollars!) we see a stunning money devaluation (or gold price rise) of almost a factor 20. However, if we take into account that the change happened over a period of 41 years, on average it is ‘only’ 9.97 percent annually.

Well, that’s still quite a lot.

Fiat money

The term ‘fiat money’ comes from the Latin word ‘fiat’, which means ‘let it be done’. So fiat money is money that has value because a government says so. Fiat money is valuable by decree. It is legal tender, lawful money.

Fiduciary money

Fiduciary money relies on trust. If experience shows that money will always be accepted in shops to buy things, you get to trust the value of that money. If that trust is never betrayed, it remains.

If everybody trusts that money is valuable, is actually becomes valuable by that trust alone: the shop owner accepts my money, because she too trusts that her suppliers and staff and the mall owner and the bank will accept that same money, as payment for purchases, as salaries, as rent for the shop building, or as interest for a company loan.

Gold backing

Modern money is usually not fully backed by gold. The central bank doesn’t have enough gold in its vaults to back the value of all the outstanding banknotes.

The paper money that is issued by the central bank is however still backed by some gold and by other assets. Any balance sheet, by definition, must have the same total amount in assets (debits, left side) as in liabilities (credits, right side). The European Central Bank publishes its balance sheets in its Annual Reports, and there will probably be similar public reports by other central banks too.

Regardless of what the backing of modern money actually is, the value of money as perceived by the public, to a large extent relies on trust. All modern money is in fact fiduciary money.

You cannot eat gold

Strange though it may seem, gold too, in a way is fiduciary ‘money’.

Gold is valuable because of its scarcity and because it has useful industrial applications, like on contacts in electronic equipment.

You cannot eat a banknote, but gold too is inedible, as King Midas already found out in antiquity. And gold is not a good building material (too soft) and not suitable to make cloths from.

But everybody agrees that gold is very valuable, because experience shows you can sell it, even in small quantities, for a lot of money.


Copyright © 2012 R. Harmsen. All rights reserved.

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