The Origin of Money and Definition of Fiat Monetary Systems

[Editor’s note: This article is a part of The Fraudulent and Ruinous Nature of Fiat Monetary Systems. This version is slightly expanded]

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The origin of fiat or paper currency is typically traced to China. A fiat currency is an unsound form of money with an unlimited supply typically issued and imposed by a government. It lacks a connection to an independent anchor of stability, reliability, and honesty, a role historically played predominantly by silver and gold. The Song Dynasty, which ruled China from around 960 to 1279, is credited with issuing the first unbacked paper money, establishing the first fiat currency around the 10th century CE.

For most of history, paper currencies functioned as representative money, meaning that a paper note represented a promise to repay a specified amount of commodity money to the bearer upon demand. Over time, people became accustomed to using paper notes as currency as they were more practical for daily use. As a result, representative money became the primary currency in most places, maintaining redeemability.

Governments typically impose a fiat currency on people through deceptive and coercive methods. The term “fiat” comes from Latin and means “let it be done,” used in the sense of a government decree or command. This illustrates fiat currencies as money by government order and imposition, not a choice and product of market economies. Existing fiat national currencies are also money forms based on coercive government imposition using laws such as legal tender, making this approach unethical.

Note that the trust and stability of fiat currencies originate from their initial connection (redeemability) to commodity money. This is a crucial point to recognize as some statist economists, in their attempts to establish money as a state invention, often overlook that representative money and, later, complete paper/fiat currencies gained trust and stability from their initial tie to commodity money. For instance, the United States dollar was initially defined as a specific weight and fineness of silver and gold. According to some sources, the dollar was initially defined as 416 grains of fine silver and 1/20th of an ounce of gold.

For most of its history, the British pound sterling was a specified quantity and fineness of silver, among numerous other currencies. Silver and gold have been the most widely used commodities as currency across different cultures and throughout history. The history of money is essentially a history of commodity currency.

While the euro has been a fiat currency since its inception, it is essential to recognize that it emerged from a context of European currencies once tied to commodity money. This historical tie to commodity money is a significant part of the euro's past. Moreover, the euro is ultimately a derivative of the U.S. dollar, whose connection to silver was phased out in the 1960s, and the remaining link to gold was removed in 1971, 53 years ago.

Like the euro, contemporary currencies created as fiat money exist in the context of the fiat dollar standard and are thus derivatives of the U.S. dollar. The dollar, in turn, is a derivative of commodity money. The Nixon administration’s severance of the remaining link between the dollar and gold on 15 August 1971 made the dollar a completely fiat currency.

With that policy decision, the world’s national currencies also became fiat due to the nature of the Bretton Woods gold exchange system established in 1944. The dollar was linked to gold at $35 per ounce, while other currencies were linked to the United States dollar, with the option to redeem their dollar holdings into gold.

The United States government’s fateful decision to end the Bretton Woods gold exchange system led to the present era of fiat monetary systems, marked by rampant (monetary, asset, and price) inflation, increased disarray in the economics field, and worldwide economic turmoil and destruction.

As Kevin Dowd (2001) rightly points out in his paper discussing the emergence of fiat currency:

Any sensible story about the emergence of fiat money must therefore come to terms with two fundamental facts, both of which are ignored by recent literature that attempts to explain the emergence of fiat money by means of a great leap forward from a barter to a fiat monetary equilibrium: the fact that fiat currencies always arose out of previously convertible currencies, and the fact that fiat currencies always arose from subsequent state intervention to make those currencies inconvertible.

A fiat monetary system is an unsound monetary arrangement typically state-imposed and managed by a central bank. It features an irredeemable currency detached from a valuable commodity like gold or silver, lacking an independent basis of honesty, stability, and reliability. Additionally, fractional reserve commercial banking, which creates non-currency money mainly by lending it into existence, is a crucial part of the existing fiat monetary systems. Fractional reserve banking is a banking system where commercial banks are required to maintain only a fraction of deposits as cash reserves for withdrawal while also having the ability to create money through lending and other banking operations.

In a sound currency system, there are material limits to currency and credit creation. Under fiat monetary systems, such as the existing ones, there are practically no limits to currency and non-currency money creation. Present fiat monetary systems include a fiat national currency in the form of notes and coins and non-currency money (book or credit money) created mainly by fractional reserve commercial banks through lending activities.

Note that central banks issue both currency and non-currency money, while fractional reserve banks issue only non-currency money. In other words, existing monetary systems under the fiat dollar standard contain two distinct yet closely related fiat parts.

As the social philosopher and economist Manuel Tacanho has clarified in his debate-settling work on fractional reserve banking, Fractional Reserve Banking Is Fraudulent and Ruinous, these two fiat parts constitute the profoundly unethical, fraudulent, and ruinous nature of existing fiat monetary systems. Tacanho (2024) remarks:

Fractional reserve banking is a doubly fraudulent commercial banking model. It is fraudulent when banks use funds from non-interest-bearing accounts to issue loans, make investments, or deposit them at an interest-paying central bank facility, as this practice constitutes an infringement of property ownership rights. It is more egregiously fraudulent when commercial banks create (non-currency) money, meaning they conjure up purchasing power by lending it into existence. Therefore, the interest payments gained over the loan’s duration are partially or entirely fraudulent. A society with a fractional reserve commercial banking system and a central bank has a triply fraudulent monetary system. A monetary system that constitutes a confiscatory structural injustice and leads to ruinous consequences.

Highlighting the foundational and central role money plays in enabling modern societies to function and thrive is essential to more appropriately comprehend its far-reaching implications for a nation’s economic, social, cultural, and moral development.

Money is the lifeblood of the economy, as it represents purchasing power, intermediates economic transactions, and communicates crucial information, incentives, and disincentives that guide the decisions of economic actors. This provides an ethical and effective system for economic decision-making that coordinates the economy in a noncoercive, optimal, and beneficial manner.

Money is a physical or digital product that facilitates the exchange, account, transfer, and store of economic value (goods and services). This makes money the cornerstone of indirect exchange societies and the fundamental good in the economy, as it plays vital and interconnected roles as a medium of exchange, instrument of account, and store of purchasing power. Money can be succinctly defined as a tool that facilitates economic activities and human collaboration within and among societies.

There are three types of monetary systems: sound, semi-sound, and unsound. A sound monetary system is based on a commodity or commodity-linked currency with no fractional reserve banking. This means an honest, stable, and reliable currency system tied to an independent basis of trust and consistency, like gold. The nilar is an example of an entirely sound monetary system. A semi-sound monetary system features a partially backed or convertible currency, typically combined with non-currency money created by commercial banks.

The monetary systems in the West and much of the world from World War I to the establishment of the Bretton Woods monetary system are examples of semi-sound monetary arrangements, which had some gold backing (approximately 40 percent). Unsound monetary systems rest on completely fiat currencies, lacking an independent anchor of honesty, stability, and reliability, typically combined with fractional reserve banking.

Fiat monetary systems are characterized by arbitrariness, high counterparty risk, currency debasement, pervasive instability, low reliability, and trustworthiness. As indicated earlier, the U.S. dollar and other contemporary currencies are examples of unsound money, being completely fiat currencies. They can be easily created with practically no legal or material restrictions on the amount that can be issued.

The Institution of Money is Not a State Invention

Schools of statist economic thought claim that money originated from the state through the imposition of taxes, forcing society to use the state-issued currency for this and other purposes. State theories on the origin of money are flawed and ideological. It is indeed a fact that fiat currencies are created through state intervention. This is accomplished by ending the connection (redeemability) of representative money to commodity money, which is the source of their trust, acceptability, and stability. However, it is unreasonable, illogical, and outright absurd to claim that the institution of money is a state invention.

While lacking a solid foundation, claims that money originated with the state are not unexpected. Western economics has been in profound disarray for some time, dominated by state-centered economic models with coercive, fraudulent, contradictory, and repressive policy implications. This dominance reflects the current statist global order established by Western imperialist states, which has significantly shaped the development of Western economic thought. As Tacanho (2024) notes in Money Demystified: Understanding Why, How, and What It Is:

The inclination towards statism among academics is rooted in the historical development of economics and other social sciences in the context of state-centered societies with imperial, thus extensively interventionist governments. Consequently, governmental institutions, directly and indirectly, employ most economists and other scholars. Moreover, producing or promoting pro-state models can lead to fame and fortune through prestigious positions and accolades. This situation has shaped the economics profession for over a century, especially since World War I.

Contrary to claims by some statist economists, such as those of the chartalist school of monetary theory and others, who argue that money originated with the state, money (and credit) is neither a product invented by bureaucratic design, coercive authority, or deliberate invention. Money is an institution that has emerged organically through gradual development processes of experimentation and adaptation over an extensive period.

Throughout history, numerous commodities have served as currency, ranging from basic items such as beads, shells, and cacao beans in Mayan civilization to gems to metals and other products, illustrating the decentralized, voluntary, and organic nature of monetary evolution. From the African civilizations of the Nile Valley to the Greeks and Romans, from the Middle Ages to contemporary times, commodity money, mainly silver and gold, has naturally emerged as the universally trusted and preferred currency form—without state design or coercive imposition.

In other words, the institutions of money and credit are not state inventions. Money and credit are products of human action but not products of human design, much less products of intentional state design. The state could not have created or invented money because the concept of money (and credit) existed before the establishment of organized governments, the state.

Anthropologists, archaeologists, and historians have yet to present compelling evidence of bartering societies. This highlights that the state could not have invented money, as it predates organized governmental structures by an extensive margin. This also implies that evidence of the use of money can be traced as far back as records allow it to be viably researched, indicating that a commodity available and valued in a particular place and time played a role as a form of money, performing one or more of its functions.

For instance, Africa, the birthplace of humankind and the continent with the most extended history, has a written and oral history dating back thousands of years. Evidence of various commodities such as gold, cowrie shells, copper, and other products used as currency is present throughout African history, including in stateless (yet orderly) societies. The concept of money, stemming from prehistoric periods, precedes most human institutions, including the state.

The chartalist school and other state theories on the origin of money, claiming that it is an invention of the state, are making an unfounded claim. The notion that the institution of money is a state invention is manifestly preposterous, as it is among the earliest human institutions and certainly precedes organized government systems.

Money (and credit) was not invented by the first tribal chief, the first king, or the first government. As noted above, money is a product of human action but not a product of human design, much less a product of intentional state design. Money originated naturally through a voluntary and decentralized process of adaptation and experimentation over time as a tool to facilitate economic activities.

Various commodities have been freely used as currency, illustrating the market-driven nature of the monetary evolution. This organic process did not involve coercive and bureaucratic methods of state design and management. The state takeover of money and management of currency systems occurred much later in monetary evolution.

It is not by state design or decree that silver and gold have been the primary forms of currency for thousands of years across cultures. Even today, over 50 years into the fiat monetary era, human nature continues to perceive commodity money, particularly gold and silver, as natural money, being honest, reliable, and trustworthy currency forms independent of government/political structures.

The evolution of money is a testament to the transformative power of human inventiveness and entrepreneurial action. It illustrates how people can enterprise, trade, and collaborate to improve their circumstances without needing top-down design with a coercive and bureaucratic approach.

Money and credit are not institutions crafted or introduced by the state. These foundational institutions existed long before the establishment of organized government structures and arose organically through human interactions rather than as deliberate inventions of specific individuals, groups, or organizations. Money and credit did not originate from coercive authority, bureaucratic design, or government mandates.