On 21st November, 2008 IMF has approved a 23-month Stand by Arrangement for Pakistan the amount of US$7.6 billion to support the economy of Pakistan. The total amount was 500 percent of the country’s quota under the agreement.IMF Board under the Fund’s fast track Emergency Financing Mechanism procedures had approved this arrangement.
In General Musharaf’s era, the fiscal policies were led the country into bankruptcy. Consequently, foreign exchange reserves were reduced, capital inflow decreased and currency was depreciated. As a result, Pakistan had to face the problems of budget deficit and it will have to take loan from IMF but everyone was unaware of the conditions imposed by IMF that were to raise the duty by 24% in three phases % in Oct, December quarter, 12% in Jan-March and 6% in April-June.
There was two-fold purpose of this agreement:
To increase the macroeconomics stability by tampering policies and to increase social stability by supporting the poor and miserable Pakistan. But there was a confliction between Pakistan Govt. and market fundamentalists.
Under the IMF agreement, SBP blocked forex to finance crude oil imports and as a result Pakistan’s currency was weakened. So Pakistan increased the interest rates that resulted bad effects on economy and middle-sized business activities and on farmers. Some people believed that the higher interest rates will encouraged the FDI but meaningless.
Although Pakistan didn’t comply with the deadlines yet it got $1.13billion. IMF declared that although is unable to fulfill the conditions under the agreement yet it gets $1.13 billion aid. The deputy managing director of IMF Murilo Portugal said that there have been settled down the important and political tax reforms and these will be continuously moving ahead. He said that Pakistan’s condition would be miserable due to increase spending on security, inflation, energy sector problems and decrease in revenue and foreign investment. Moreover, United State forces Pakistan to send its troops to North Waziristan to tackle with Taliban.
IMF Loan to Pakistan
(History and current perspective)
No doubt IMF acts as a lender of last resort for a country like Pakistan facing problem like budget deficit, balance of payments, and destabilization of currency, liquidity problems and foreign exchange reserves.
Instead of taking new actions in bad circumstances like inflation up to 25%, decrease in exchange rates and increase in imports by 35.2%, Pakistan asked IMF to give loan of $7.6 billion to meet its problems or deficiencies.
Before this we discuss the impacts of IMF on Pakistan’s economy. Firstly, we must have idea about IMF loan. In 1988, Pakistan became the member of IMF. Up till now Pakistan has obtained 11 installments of loans from IMF. Almost 6 installments were obtained in the era of Benazir Bhutto, 2 were obtained in Nawaz Sharif’s era and 2 in Musharaf’s period.
During the last twenty years, 44% of the agreed amount has been obtained and it is noted to see that 9 installments are obtained in Civil Govt. whereas only 2 installments obtained in Military Govt.
Many conditions were imposed on Pakistan for optimal utilization of funds. There is greatly positive as well as negative effect on Pakistan. Pakistan felt that its GDP growth rates have been decreased but in Musharaf period, he turned down to IMF loan.
Current Perspective Currently IMF has influenced Pakistan’s economy positively as well as negatively. It has increased liquidity, good credit rating, low default risk, encourage foreign exchange reserves, investors’ confidence to invest in money as well as capital market.
But it has also bad affects on our economy like striating the policies, increasing poverty and unemployment problems. For example, 1% increases in sale tax, deletion of subsidies in domestic petroleum products, increasing excise duty etc.
The reasons due to which Pakistan is bound to get debt concession from world According to poverty reduction strategy paper (PRSP) issued by IMF regarding Pakistan entailed that Pakistan has paid a large amount on front line war. During last five years, our direct and indirect cost almost Rs.2 trillion. Being Pakistanis we argue that it is not our war but the war of US. That resulted unbelievable affects on Pakistan economy and people. Rather to get loan from IMF, all parties in parliament should get together to discuss how to get rid from IMF loan. That will result decreasing debt service cost and decline our liabilities. It will decrease non-developmental expenses and the optimal utilization of the resources to the Govt. sector. Pakistan’s situation regarding debt structure is not so bad as the media has declared. Up to March 2010, the total debt of Pakistan is US$54.5 billion. In this amount US$14 billion is of 18 nations called Paris Club. US$1.8 billion is bilateral lenders and others like Asian Development Bank, Islamic Development Bank, World Bank etc.
After requesting to Paris Club, China, Saudi Arabia, Japan, Germany and Kuwait, Pakistan was able to get relief of US$15.8 billion. But this is not fair. It is noted that Credit Default Swap (CDS) of Pakistan has been boosted up after the murder of Benazir Bhutto. That resulting in decreasing the foreign investment in the country, reducing liquidity, high ring interest rates and economic crises that was commenced from August-September 2008. During SWAT war, the CDS of Pakistan was increased up to 30%. It is not a good position. That’s why foreigners hesitate to invest in our country.
Request to IMF for financial support after floods. The request is sent to the Managing Director of IMF Mr. Strauss Kahn regarding financial support of Pakistan. It was stated that the flood ruined more than 2 million families, 1540 were died, over 2320 were wounded. Almost 15million (10% of total population) is affected. The condition of the country is more severe. It requires a lot of funds to rehabilitate the people and definitely there should be financial assistance.
Although the Asian Development Bank and the World Bank have promised to pay damages up to October but it is obvious that our requirements are greater than our sources. That’s why we are looking for the quick financial support by the IMF to tackle the severe economic condition. We assure that the grant will properly utilized by providing food, shelter, health and other basic services without disturbing the financial market and decreasing foreign exchange reserves. The IMF support will also help us externally to stand in International Market. We are still agreeing with the conditions laid down under the Stand-By-Agreement (SBA).
The effects of flood on economy and budget Due to flood the country’s conditions, infrastructure have severely damaged. Particularly agriculture sector that contributes 21% in GDP and 45% in employment is harshly damaged. The major harm is of cotton, rice and sugarcane crops. Due to damage crops, there is higher inflation in rural areas for flood and other items. Other basic necessities of life also disturbed due to floods. Inflation increased from 11.7% to 13.5%.
Financial sector is also affected. Many banks were blocked in floods affected areas. The floods have also budsetry affects. Income from taxes has been reduced due to poor economic condition. Balance of payment has also disturbed. Imports are greater than exports.
What’s our reaction towards floods? The Government of Pakistan is ready to offer aid and mobilize the resources. In the affected areas by the floods, the (NDMA) National Disaster Management Authority has offered solvage and release services thousands of people have been procured and basic necessities have been disturbed.
The United Nations has controlled the operations by what it requires US $460 million of which US $275 million obtained from private international and public donors. ADB committed to support with US $2 billion. Further we also introduced tentative income tax surcharge of 10%. In spite of these efforts, our requirements are greater than our sources and consequently it resulted in push 4% deficit of GDP.
SBP is also doing an important role to compensate the economy and financial sectors by friendly working with banks to make easy the easily flow of credit and to international development agencies to enlarge and pass on the previous facilities for financing. It has also encouraged the small and medium-sized business concerns and micro-finance projects in the areas affected by the floods. SBP has also ensured that the international trades and the financial relations are normally working. There is no need to oblige any new restriction on the making of the payments and for transfer of international transactions. We will be able to change our GST and introduce RGST that will cover value-added tax (VAT) that will enable us to reach at our desire sustainable level by acquiring the tax revenues. We will take steps to limit the fiscal deficit that is 4% of GDP. Once the damage needs evaluation is completed, the macroeconomic structure will be re-shaped.
The Types Of Money Used Today Economics Essay
The types of money used today include; Coins, Paper currency, Bank drafts, Money orders, Stocks, Bonds, Treasury bills, Credit cards, ATM cards, Options, Gift certificates, Cheques,Travelers Cheques and many more. Money is converted into two categories, commodity and fiat money.
2.2.1Commodity money What constitutes a commodity? A commodity is generally accepted, without further clarification, as anything that can be bought or sold. This prompts further questioning. What is the community’s present accepted means for buying and selling? The answer is,money. A commodity therefore is a thing to which a money price can be attached and which can therefore be bought or sold with money. If money itself is a commodity, then money is a thing that can be bought or sold with money. The above reasoning not only involves a vicious circular logic of explaining and defining something in terms of itself, but also paves the way for an ascending infinite inflationary spiral (Peter Lock 2008).
According to Peter Lock (2008), the definition of a commodity needs to be modified if it is to be consistent and to avoid all circular logic. An economic commodity is any marketable goods or service which has an intrinsic value in itself and whose value can be relatively assessed using an extrinsic suitable stable non-commodity money standard and hence bought and sold. In other words, an economic commodity is any marketable good, other than money, which money itself can buy. Modern money either as bits of plastic or paper, or as numbers in ledgers and computer memories, has no intrinsic value in itself. Its only value is its otherness. It does perform a valuable service in the marketplace by measuring the value of all other goods and services and facilitating their exchange.
The mindset of money as a bartering device should not be included in or confused with the mindset for its use as a commodity. Their purposes and functions are self-contradictory, being diametrically opposite. The former exists as a stable extrinsic measure of worth for a community as a whole to use. The latter as an unstable intrinsic measure of marketplace purchasing power for individuals to abuse in their exploitation of the whole global community for their own personal aggrandizement and exercise of usurped power (Peter Lock, 2008).
According to Peter Lock (2008), as long as money is treated as a commodity, uncertainty and insecurity must result. It is not a question of throwing the baby out with the bathwater. It is simply a challenge to devise a system whereby the rich well fed haves can keep their fat share of humanity’s commonwealth cake and at the same time let the poor hungry have-nots eat a just and reasonable thin slice of it as well. Money as a commodity only exists for the personal profit and increasing wealth and power of the haves: some of the rich get richer, all the poor get poorer. In an economic system where money is self-self functioning in positive feedback as a commodity, the evil treatment meted out to the have-nots who constitute the vast majority of the community becomes more and more inhumane.
The term commodity money can be given to the kind of money that is at the same time a commercial commodity. Commodity money has an intrinsic value and that means it is considered to be worth something in its own right rather than simply being a token of financial value such as a banknote. The commodity itself constitutes the money, and the money is the commodity. The best known form of commodity money is gold or silver coins, though any commodity can fulfill this role. The commodity itself; since more is being produced and less being used for non-monetary purposes, the resources devoted to additional production and the benefits forgone must be counted as the price of the system. Examples of commodities that have been used as medium of exchange include gold, silver, copper, salt, peppercorns, large stones, shells, alcohol, barley and cigarettes, just to highlight a few. These items were sometimes used in a metric of perceived value in conjunction to one another, in various commodity valuation or Price System economies With a commodity money balances is part of the markets for goods and services. Use of commodity money is more the same with barter system.
The use of shells or ivory was nearly universal before humans discovered how to work with precious metals; in China, Africa, and many other areas, use of cowrie shells was common. Historically speaking, many different metals have been used as standard money: iron in ancient Sparta, tin in ancient Syracuse and probably also in early Egypt, copper in early Palestine and in early Rome, and brass until recently in many parts of China. In modern times, however, monometallism has been based mostly on the so-called precious metals, silver and gold, with an increasing preponderance of gold since the latter part of the last century.
Historically, the strongest and most stable currencies were those backed by gold and silver. It was this gold/silver backing that gave the currency its intrinsic value. In most cases, a country’s currency was actually gold or silver coins. Gold and silver have always been a universal form of money and measure of wealth providing stability in an otherwise unstable world (Tony DiCicco, 2002).
A commodity money can give rise to a large amount of price instability if either there are large changes in the supply of the commodity or if there are large changes in the non-monetary use of the commodity. An example of a commodity money that gave rise to price fluctuations is the cigarette currency used in POW camps in the Second World War. The price of goods in terms of cigarettes depended on the relative availability of cigarettes and goods. If no cigarettes were received in the camp for some time, the supply of them would diminish (because prisoners would use them as commodities: they would smoke them) and their value would rise. A rise in the value of cigarettes meant that cigarettes bought more, or that prices fell. When a shipment of cigarettes would arrive, their increased availability would cause their value to drop, which meant prices would rise. Its stated that the erratic delivery of cigarettes and the resulting waves of inflation and deflation were a major problem in the mini-economy of the POW (camphttp://ingrimayne.com/econ/Money/Commodities.html).
Colonists often resorted to the use of commodity money, where a colony’s principal commodity would circulate as a medium of exchange. The Massachusetts Bay Colony used corn and beaver skins as its medium of exchange. In the Southern colonies, it was tobacco and rice; and throughout most of the colonies, animal skins, corn, powder and gun shot, and livestock were often used. Since the market value of commodity money was determined by supply and demand, its value as money often decreased when there was an over supply in the marketplace. In addition, commodity money lacked uniform quality, and was prone to spoilage, difficult to transport, and costly to store (http://www.bos.frb.org/education/pubs/historyo.pdf ).
pictures below shows examples of commodity money that where used: Gold Silver Shells Barley 2.2.2Fiat money The currency we all use today is legal tender for taxes and debts. It has no intrinsic value, it is not convertible and it is not tyrannically imposed on all transactions. This money – fiat money – was born in Massachusetts in 1690. Historians have claimed that it was a simple wartime substitution of fiat money for specie, as has happened many times since then, but this view is anachronistic. Later governments learned from Massachusetts that fiat money is a good wartime emergency, but for Massachusetts this was not an obvious idea (Dror Goldberg).
Dror Goldberg mentions that Massachusetts had to issue money to pacify mutinous troops who returned defeated from war. However, formally issuing money, and backing it with land (as was then standard), would have been fatal for the long-run independence of the colony. Massachusetts had lost its charter in 1684, partly because it minted its own coins (a violation of the royal coinage prerogative). Moreover, all the colony’s land was temporarily considered to be the king’s land from 1687-1691. In 1690, when Massachusetts had to issue money, its agents were lobbying for a new charter in London. It could not afford to upset the king by violating his coinage prerogative again and backing money with his land. The solution was to issue IOUs, as any English subject was allowed to do, not back it with land, and not force it on trade. Like any IOU issuer the colony could offset its credits with it, namely making it legal tender for taxes. It was also made effectively legal tender for debts in an elaborate, dishonest way. The outcome was fiat money (Dror Goldberg).
The Massachusetts Bay Colony issued in 1776. The evolution of commodity money into paper in America
Paper money first appeared in America in in the late 17th century. In 1690, the government of the Massachusetts Bay Colony, in an effort to increase government spending while avoiding the unpopular act of raising taxes, began printing paper money to pay for its expenses. To convince the Massachusetts Bay colonists to accept the paper as payment, the government promised to redeem the paper in gold and silver coin collected in taxes at a later date. It also promised to never print paper money again. While both promises were quickly broken by the government, is is interesting to see that, again, what caused people to begin accepting paper money as payment for goods and services, is the understanding that the money could ultimately be redeemed for tangible wealth in the form of the commodity money in use at the time (Chris Lind).
The pictures below is an example of fiat money: Federal Reserve Note 1941 Federal Reserve Note 1950 The evolution of commodity money into paper in China
Paper money first arose in China around 800 AD during the T’ang Dynasty. Prior to the existence of paper money, a merchant selling his goods in the city of Szechuan, risked loss by theft as he transported his commodity money and unsold goods back to his home city. As a way of earning revenue, the Chinese government, in posession of fortified strongholds in each city to store tax revenues, offered the following service. For a fee, a merchant could deposit their gold and silver coin with the government in city A. In exchange the merchant received a paper receipt for the gold deposited. When the merchant arrived back home at city B, he could go to the treasury of that city to redeem his paper reciept for the commodity money in use. Over time, as people learned that the commodity represented by the paper would actually be there, merchants began buying and selling with the paper receipts themselves (Chris Lind).
Kuan note is the oldest known banknote in the world (Mike Hewitt) However, its use was very short-lived, by 1455, after over 600 years, the Chinese abandoned paper money due to numerous problems of over issuance and hyperinflation.
The term fiat money can be given to money that comprises things with a special legal qualification and the money used today is fiat money.’Fiat’ means let it be done or by order of authority. Fiat money basically means that the currency has no intrinsic value (nor can it be redeemed for precious metals or something of intrinsic value) and the money is based solely on faith. Rather, the currency is only backed by the goodwill of the government that issues it. Normally the government is the one that declares legal tender. With fiat money its not real but it represents goods and services that it can buy thus it can be defined as the baskets of goods and services that it represents. For fiat money to be valued, the money supply must be limited and it must be impossible to counterfeit (PÄ±nar Yesin 2010).
Fiat money is created by a narrow cadre of globalist bankers that seek a new World order. Fiat money is created out of thin air. The fiat system is based on debt. We owe and they are owed. With the power they accrue, a plan has been launched to reorganize all aspects of human life. That plan is called Agenda 21 or Sustainable Development. It is a U.N. program, agreed to by 178 nations, that is designed to create a world order where human beings are regarded as biological resources. The evolving system does not recognize unalienable rights (Michael Shaw, 2009).
Since fiat money has no direct legal connection to a commodity money there is no real economic cost to its production, the supply of a fiat money can never be self-limiting; and the value of a fiat money is always largely a matter of public confidence in the economic or political stability of the issuer. Historically every major fiat money have self-destructed in what is popularly called ‘hyperinflation’ caused by either unlimited increases in the supply of that fiat money by the issuer or accelerating loss of public confidence in the continued value of the money or the economic or political fortunes of its issuer or both. Steve Elwart says that today, fiat money will always bring on inflation for two reasons: 1) Politicians like to induce inflation because it gives the people the illusion of prosperity and 2) its declared value is much higher than the cost of producing it. Whether it is a $1 or $100 bill in fiat money, it costs only 4 cents to produce. In today’s electronic age, the production cost for new money is zero since money creation is just a keystroke and an entry in cyber-space. On the other hand, in history, if you had a $20 gold piece, the cost of that gold piece, less the cost to produce it, was about $20 (Steve Elwart).
The Barter system was prevalent before the origin of fiat currency. In this system, commodities were exchanged for commodities. For example, if one person need rice and the other one need coconut, the person who has cultivates rice has to search and find out the person having coconut. Only then the exchange will take place. This itself was the serious disadvantage of barter system. For some times the different commodities acted as money and they were named as commodity money. After years of a coin system the paper fiat currency came in to existence. In the coinage, a gold smith acted sometimes as a banker. A government body started to control the printing of all types of moneys. Banks started to deal with money. They accepted savings and gave loans in the form of money. Apart from these transactions, banks started to generate bank money ( Robert Mendez).
Modern society again replaced old money with other new forms of money like, demand drafts, credit cards, etc. Now we don’t need to keep a liquid form of money with us. All our transactions can be made by using credit cards. We can do all our shopping with these cards. Even if money is used in different forms, the importance of money is still not deteriorated.
According to Steve Elwart in his research entitled “Commodity Money and Fiat Money: A Bushel of Wheat for a Penny”, says that a government puts fiat money into circulation first by connecting it to a gold or silver standard, but then cuts the link and says that gold and paper are no longer convertible, making the piece of paper “legal tender for all debts public and private.” It is obvious that debtors would be very happy if the pa-per money lost its value because they could pay their debts with inflated currency. In a letter to Edward Carrington in 1788, Thomas Jefferson wrote, “Paper is poverty â€¦ it is only the ghost of money, and not money itself.” Jefferson died bankrupt because of the early United States money (monetary) pol-icy based on paper.
It is not that fiat currency is a new invention. Fiat currency actually made its appearance over 1,000 years ago. China was the first country to issue true paper money around the 10th century A.D. Although the notes were valued at a certain ex-change rate for gold, silver, or silk, conversion was never allowed in practice. The bills were supposed to be redeemed after three years in circulation, but as more bills were printed with the older notes being refused redemption, inflation became evident. Government measures to prop up the currency were unsuccessful and it fell out of favor (Steve Elwart) .
Steve continues to say that at this point, people start to feel the pinch of their money buying less. They demand that their government do some-thing. Since studies have shown that voters only have a memory of one year when it comes to politics, politicians will make sure that the economy is good in an election year.6 They will artificially stimulate the economy to give voters the illusion that times are good again and reelect the incumbents. This lasts only so long and inflation, with its problems kick in again. This cycle of increasing the currency supply and price inflation ultimately ends with the collapse of the currency, sometimes preceded by hyperinflation. (Hyperinflation and its cultural effects will be covered in Part 3 of this series.) Surprisingly, the country has not learned its lesson and the devalued fiat currency is replaced with yet another fiat currency. Greece is a perfect example of this cycle (Steve Elwart).
Steve Elwart says the Greek drachma was minted in gold and silver in ancient Greece and made its reappearance as a fiat currency in 1841. Since then, the value of the drachma decreased. During the German-Italian occupation of the country from 1941-1944, hyperinflation ravaged the country, ending with the issuance of 100,000,000,000 (100 billion)-drachma notes in 1944. After Greece was liberated from Germany, old drachmae were ex-changed for new ones at the rate of 50,000,000,000 to 1. Only paper money was issued, again a fiat currency. Greece then went on a program of deficit spending for social programs and inflation started once again.
In 1953, in an effort to halt inflation, Greece joined the Bretton Woods system and the drachma was revalued at a rate of 1000 old drachma to one new drachma. In 1973 the Bretton Woods System was abolished; over the next 25 years the official exchange rate gradually declined, from 30 drachmas to one U.S. dollar to a ratio of 400:1. On January 1, 2002, the Greek drachma was officially replaced as the circulating currency by the Euro (again a fiat currency).
Today, Greece is once again is in trouble. After years of continued deficit spending and the government’s easy monetary policy, Greece’s financial situation was badly exposed when the global economic downturn struck. Very quickly, the government’s “creative accounting” practices were exposed. The national debt, put at â‚¬300 billion ($413.6 billion), is bigger than the country’s entire economy, with some estimates placing it at 120 percent of gross domestic product in 2010. The country’s deficit-how much more it spends than it takes in-is 12.7 percent (Steve Elwart).
This time though, Greece just can’t inflate their way out of the problem. Now that they are on the Euro (in the “Euro-zone”), they have little control over their monetary policy. All their loans are in Euros and they must pay back the loans in Euros. One way to balance the national books is to implement harsh and unpopular spending cuts. Another way is to default on their debt. This would seriously damage the Euro as other countries look at default as a way out of their financial problems. (In fact, financial experts are predicting the demise of the Euro in as early as five years.8) A third way out is to separate itself from the Euro, go back on the drachma (fiat currency again) and then set an exchange rate of the drachma to the Euro at an artificially high number. The cycle of fiat money would then begin again. As long as a country is on a fiat currency, inflation is sure to follow. Using a fiat currency could well reduce a civilization to work an entire day for a “bushel of wheat,”(Steve Elwart).
Failures of Government fiat money History has taught that lodging monopoly power over the nation’s stock of currency in a purely discretionary central bank, unconstrained by a monetary constitution, is highly dangerous. The money-process is likely to become politicized, with monetary policy becoming subservient to fiscal policy and with monetary authorities exhibiting a bias toward inflation. James A. Dorn mentions that a study of about 30 currencies shows that there has not been a single case of a currency freely manipulated by its government or central bank since 1700 which enjoyed price stability for at least 30 years running. Although the Fed has achieved intermittent price stability since its inception in 1913, its long-run performance has been unsatisfactory, especially when compared to commodity-based standards such as the classical gold standard. The issuance of fiat money by governments is, in truth, a white collar crime; and, as happens when white collar crimes are discovered, a highly visible paper trail leads directly back to the wrongdoers-in this case, the central banks (Darryl Robert Schoon).
In fiat based economies, time is the enemy and 95 years have passed since fiat money was introduced into the US. In America and elsewhere time is passing and the clock is ticking and recently it’s been sounding more and more like a time bomb (Darryl Robert Schoon) .
Comparison between types of money Fiat money is the term for a medium of exchange which is neither a commercial commodity, a consumer, or a producer good, nor title to any such commodity: that is irredeemable paper money. In contrast, commodity money refers to a medium of exchange which is either a commercial commodity or a title thereto. There is no doubt that fiat money is possible. Its theoretical possibility was recognized long ago, and since 1971, when the last remnants of a former international gold (commodity) standard were abolished, all monies, everywhere, have in fact been nothing but irredeemable pieces of paper (Hans-Hermann Hoppe).
As asserted by Cary A. Deck, Kevin A. McCabe and David P. Porter ( ),fiat money is a convention that allows individuals to complete trades without relying on the coincidence of wants or diverting valuable commodities to serve as money. In order for individuals to accept intrinsically worthless fiat money in exchange for valuable goods, the agents must believe that the money can be used to complete subsequent purchases of other goods or services.
Advantages of Commodity money According to the information about commodities monies on the internet, the reduced value of the money will encourage people to use the item more in its commodity use. For example, if gold serves as money, and its value drops, people will increase their use of gold for jewelry, tableware, and artistic purposes. Their actions will reflect the law of demand: whenever a commodity becomes cheaper, people use more of it. Thus if there is a sudden influx of gold into a country that uses it as money, part of the influx will be diverted to its commodity use, and the effects on the amount of money, and hence on the price level, will be lessened. On the other hand, a sudden decline will also be cushioned, because as the commodity grows more valuable, people will transfer it from its commodity use into a monetary use. If the amount of gold declines and it rises in value, there is an incentive to melt down jewelry, tableware, and artistic objects and use the gold as money. Hence a doubling of gold may not double the amount of money, and cutting the amount of gold by one half may not cut money by one half (http://ingrimayne.com/econ/Money/Commodities.html ).
Another reason for price stability with a commodity money exists when that commodity is used by many other nations. When the price level in any one nation changes, the commodity will flow across borders to where it is most valuable( Robert Schenk, PhD, University of Wisconsin-Madison, 1977 ).
Disadvantages of Commodity Money When valuable resources are used as money, those resources cannot be used for consumption. Copper used to make pennies cannot be used to make electrical wire. The supply of money is determined by supply of the commodity. The money supply could fluctuate substantially. The discovery of new gold would mean that the supply of money would increase and the price level would rise. There is a lack of stability when a currency depends on being able to find and produce a particular naturally occurring but naturally rare substance. When gold is being used as commodity money it can be a disadvantage since the government can’t meaningfully increase the supply of gold over a short period of time, for example the Fed can be able to increase the supply of fiat money in 10 weeks by more than 100%, with gold this cannot be accomplished.
. Advantages of Fiat money Is an efficient form of money; since it can be produced costlessly, there is a gain from using it instead of something else that is both costly to produce and has alternative uses (Neil Wallace).Uses relatively little of society’s resources. Fiat money has an advantage over commodity money in the senses that the same laws that come up with laws that created the money can also make a decision to replace the money if it ever gets damaged or destruction occurs. Fiat money has more stability as compared that of gold-backed currency in the sense that commodity based currencies are inherently pro-cyclic, increasing volatility in terms of the regular business cycle and come and go recessions. This stability allows investors, capitalists and creditors to make rational, firm decisions based on sound expectations that have little room for uncertainty; and thus make more risky and subjective investments. Studies also shows that during the Great depression, countries that used fiat currency system fared more stable and much better off than those dependent on commodity-based currency.
As mentioned by Chris Lind, fiat money is generally seen as a convenience or a protectionist system; It is much easier to carry around a piece of paper than 50 pounds of gold or some other commodity. Trustworthiness; the community trusts that the paper receipt or certificate actually represents the tangible good printed on the paper. Fiat money can and still created in arbitrary amounts, and is made more available on a favorable basis to the government and commercial banks. With fiat money the Fed can be able to increase the supply by more than 100% within 10 weeks, the advantage of being able to do that is that the government can manipulate the system to mitigate panics and disasters. Take for example the last fall would have being a bigger mess if gold was the monetary numeraire
Disadvantages of Fiat Money The longer a fiat money system exists, the greater the odds of economic collapse. Over
time fiat credit money destroys economies because time exacerbates the systemic flaws of credit-based, sic capital, markets (Darryl Robert Schoon).
Fiat money is not self limiting, which can make nations which rely on this type of currency extremely vulnerable to hyperinflation. Government controls money supply and it may cause inflation by printing too much money the following example shows how fiat money can really cause inflation the example is taken from a journal by Andrew Digeson White (1933), early in the year 1789 the French nation found itself in deep financial embarrassment: there was a heavy debt and a serious deficit. The vast reforms of that period, though a lasting blessing politically, were a temporary evil financially. There was a general want of confidence in business circles; capital had shown its proverbial timidity by retiring out of sight as far as possible; throughout the land was stagnation.
Fiat money becomes worthless when its no longer used that is when the government declares. Fiat money distorts the time value of money and in so doing destroys both money and the economies that use it (Darryl Robert Schoon).