History of paper money and commodity currencies
To understand national debt we need to start with the history of paper money. The first known use of paper money was in China in the 7th century. Around a thousand years later paper money was started being used in the West in the 16th century. Paper money was very similar to a receipt when you buy items.
People who had physical valuable materials such as gold, silver and copper coins would deposit them at a bank and in return they would receive an exchange bill. They could then use this bill to withdraw their gold coins from the bank, or they could trade the bills for other items and the new owner of the bill would now own the gold coins in the bank.
Some of the advantages for this system were that your wealth was safe as you did not have to carry it around with you. Also it was more convenient to complete larger transactions as many bags of coins were not needed.
This was the perfect system as the paper currency was backed by physical goods that had actual value. This type of currency is known as commodity currency.
The bank could only print notes if it had the equivalent amount in actual wealth such as gold. This is important because if people no longer believed the paper money had any value then every single person could exchange their bank notes into gold which will always have value as there is a limited amount on Earth.
End of commodity currencies and the start of fiat currencies
The US Dollar used to be backed by gold and Silver. In 1971 US president Nixon ended this. Now that the US Dollar is not backed by gold or silver it is no longer a commodity currency and it is now a fiat currency. Fiat currencies have no intrinsic value that is deemed to be money by the law of the government. Other countries followed this path soon after.
The only reason fiat currencies like the US Dollar, the Euro and the British Pound has any value is because people think it has value. There is approximately 13.5 trillion US dollars in circulation as of 2017. If all of the US dollars in circulation is traded for gold at the current rate of $39,850 per kg then 338,770 tons of gold would be needed.
Only 182,000 tons of gold has been mined in all of human history. There is currently not enough gold to back up the amount of US dollars in circulation, let alone the other Fiat currencies.
Problem with fiat currencies
- Bond – is a piece of paper issued by a country’s government, promising to repay borrowed money and a fixed rate of interest at a specified time to whoever owns the bond.
- Central Banks are the types of banks owned by governments which can print currency. They distribute the printed currency to commercial banks. The name for the US central Bank is the Federal reserve.
The problem with fiat currencies is that they can be printed out of thin air with no actual value to them. They can be used to fund wars, get the country out of a recession, and to bail out the banks.
In order to print currency the government creates bonds and sells the bonds to the commercial banks. The commercial banks sells the bonds the central bank for printed currency including interest. The commercial banks hands the printed currency to the government and also lends it out to people.
Who is the national debt owed to
The national debt will never be paid in full by any country. When the currency is first made, you cannot print £1000 and then promise to pay £1000 plus interest, because there is only £1000 in existence.
To pay the interest the cycle has to repeated, more bonds need to be created to pay for the old bonds and their interest. The debt and interest will exponentially increase. Austerity and cutting spending can only reduce the amount the government needs to borrow by creating bonds, it cannot completely eliminate the debt.
Therefore the national debts are owed to the people who own bonds, foreign governments, central banks, investors, to summarise it up, basically the rich. Tax payers are the people who are paying for the bonds and the interest. The debt created by governments will have to be paid by future generations of tax payers.
The system has not failed yet because not enough people know about it. The governments keep printing more currency to paper over the cracks in our economic system.
Do you agree or disagree? Feel free to comment below.