What is fiat currency, how it is used and does it work? In this post, I will answer all these questions and many more.
What is Fiat Currency – Definition
Fiat currency is currency established by government law or regulation. Fiat currency is not backed by a physical commodity. (gold, silver, etc.) The value of fiat money derives from the relationship between supply and demand, rather than the value of the material that the money is made from.
In the past, most currencies were based on physical commodities such as gold, or silver, but fiat money is based solely on the faith and credit of the economy.
Although modern currency is used on a daily basis to purchase millions of items, it is actually considered fiat money because it has no real value of its own. Its value depends directly on the issuing country’s economy.
It is well known that cigarettes are used as currency in prisons. In fact, inmates will mass cigarettes and use them as a medium of exchange. In both cases, cigarettes and paper money, or even bitcoins, or whatever a currency, is simply an agreement that a particular item is a currency.
Switching back to a gold-backed regime does not mean switching away from fiat currency, it means switching to a fiat currency system where paper money is linked to a commodity.
Paper Money Have No Intrinsic Value
We all like to think that our paper money, dollars, euros, etc. have intrinsic value, whereas value in a marketplace is determined by supply and demand, not anything intrinsic. In reality, our currency system, and any currency system, is backed by absolutely nothing, except a shared agreement by everyone to use the currency.
In addition, the government’s law or regulation that makes money, in reality, is useless without the consent of the currency users.
Due to the fact that fiat money is not linked to physical commodities, the value of the fiat money depends on the strength of the issuing country’s economy, and inflation, or even hyperinflation, could result if the government issues too much fiat money. In that case, paper money will become worthless.
Fiat Money Depends on Trust
Because fiat money is not a source or fixed resource like gold, governments, and central banks have much greater control over its supply, which gives them the power to manage economic variables, such as credit supply, liquidity, interest rates, and money velocity.
On the other side, the threat of depression or serious recessions is still there and the mortgage crisis in 2007 and 2008 is living proof. A currency tied to gold is more stable than fiat money due to the limited supply of gold. Fiat money provides more opportunities to create bubbles due to its unlimited supply.
During the last couple of years, there have been many voices calling for the return to a commodity-based currency. Mr. Alan Greenspan, the former US head of the Fed, has also asked the US President to consider going back to the gold standard.
I hope my What is Fiat Currency – Definition article was useful to you. If you still have any questions let me know in the comment section.
The US dollar continues to show us signs of a significant long-term reversal lower in the making. As first proposed in January 2017, the dollar has now hit our initial lower target of 95.5 on the dollar index:
This target was derived from a measurement of the amplitude (4) of the false breakout above the 99.5 resistance zone (black lines) subtracted from this same level following the breakdown. It represents a liquidation of long contracts by those who purchased the US dollar on the assumption that Trump’s policies would overshadow any money printing by the Federal Reserve after the election.
We were on alert for the US dollar reversal starting in January 2017, as the currency continued to make lower lows after a major multi-year breakout. This was a warning sign – such immediate weakness should not occur in a strong breakout scenario.
Again, as of this week, the dollar has now hit our first target lower, at 95.5 on the dollar index.
What now?
First, please note that initial targets are just that: the first stopping point based on a technical measurement. We must use other forms of analysis to gauge the probability for subsequent movements.
Prepare For Dollar Bulls To Show Up
Dollar bulls are going to begin buying in the currency markets near 95.5. They are going to try to paint this decline as simply a higher-low in a series of such higher-lows that have formed over the past nine years. They are going to try to buy the dollar up above the recent false breakout at 103.5.
We suspect they will fail, as sellers are clearly present above 99.5 on the index. False breakouts at multi-decade highs tend to represent long-term reversal patterns.
While the price action for the US dollar has been weak over the past 3-4 months, the dollar has begun accelerating in downward momentum over the past week. There is no sign of an imminent bottom on the dollar chart, even though our initial target has been met.
Based on the deterioration in momentum, it is likely that the dollar is headed for its 2.5-year support zone between 92-93 as a next stopping point before any meaningful rally.
Visualizing a further drop into the support zone on the long-term chart:
Although a significant bounce should be expected to occur as the 92-93 support is reached, even a test of this region is a bearish long-term signal, as it opens the door to a possible massive head and shoulders top on any bounce, illustrated by the green arrows above.
Our best assessment is that the dollar will fail to hold the lower range of the support zone at 92 after a meaningful bounce. At this point, there will be little in the way of support for the dollar aside from the long-term rising trendline (magenta color), which comes in at 88. The target on a failure of support at 92 will become 80.5, equal to the amplitude of the failed advance (11.5) above the support zone, subtracted from the same support zone.
US Dollar/Gold Declining Simultaneously
Unfortunately for gold, we are living through one of those anomalous time periods in which the US dollar and precious metals are positively correlated – but to the downside.
Throughout history, gold tends to have its strongest moves when the US dollar is losing value, as gold receives bids from those looking to protect their savings against a decline in the world’s reserve currency.
However, as we can see at right, especially since the Federal Reserve meeting in mid-June, both the US dollar and gold have moved in the same direction: lower.
This is largely a market psychology phenomenon. Presently, the Fed has the markets fully convinced that it is engaging in just the right amount of money-printing to keep inflation modest but to keep economic growth strong. As a result, investors are choosing to protect themselves from inflation through the rising stock market, but are seeing little need for “safe- havens”, i.e. gold and the US dollar.
Respecting The Market
This is where our outlook may be different from most analysts in the precious metals community.
We of course know that gold and the US dollar are not both equal as per safe-havens. One is a historic store of wealth that has lasted for over 5,000 years, while the other is a fiat currency which has already lost 97% of its value in the past 100 years.
However – we also respect that market reactions are primarily determined by the psychology of its participants at a given time.
We agree that the market – in viewing both gold and the dollar as safe havens to be sold simultaneously – is acting irrationally.
However, the market can stay irrational longer than many expect.
We have no desire to be right on certain fundamentals, but to get “trampled” by the market moving opposite to us.
To do so would be akin to simply ignoring an irrational mob of people as it approaches. Perhaps the people have no logical reason for their behavior – but if we ignore them as they rush toward us, we will get hurt nonetheless.
Large market players can sell gold simply because they trust that the Fed has everything under control.
Something must change in the market psychology to alter this belief.
Gold Not Acting As Safe-Haven?
The last two days were especially noticeable in that gold failed to receive a bid, even despite weakness in both the US dollar and the broad stock market. At right we plot gold, the dollar, and the S&P 500 since Thursday:
There is an old investment adage which says: “If a market fails to move higher when it should, it is showing internal weakness.” (The implication is that absolute price weakness should be the next to manifest.)
This is the only way we can interpret the price action for gold recently. It is failing to attract buying on either US dollar weakness or stock market weakness.
If gold cannot move higher when traditionally-inverse markets are showing weakness, then when will it?
This is the question gold investors must ask themselves.
Short-Term vs. Long-Term
We are not bearish over the long-term. Irrational behavior can reverse just as quickly as it began.
But something must change as per market psychology to shake the precious metals out of their malaise. A trigger must present itself. We cannot say what that trigger will be yet – but we will absolutely see it on the charts when it occurs.
For now, subscribers continue to hold puts as protection in case of a more serious decline in the metals during the second half of the year.
Here, I present my top six reasons to buy silver. Investors I believe, are looking down on silver compared to gold, and other types of investments. If you go through this post you will see silver is undervalued therefore, a great opportunity to invest.
Silver is affordable
As we speak, silver sells at $18,36 and gold sells at $1256,94 a troy ounce therefore, an investor with $10.000, can either get 544 ounces of silver, or 8 ounces of gold.
Silver is real money
Although silver is not part of our currency, along with gold is the ultimate form of money, because it can’t be created out of thin air, like paper money or digital coins. I am talking about silver in physical form, no ETF’s futures or certificates.
Growing demand falling supply
There is a growing demand for silver globally. China’s and India’s appetite for silver is growing and at the same time industrial demand is growing too. At the same time the last couple of years, silver production has peaked and soon supply will not be meeting demand
Silver outperforms gold in a bull market.
The silver price increases more than gold in a bull market. Historically, silver is more volatile than gold. If you think there is going to be a bullish market for gold and silver, then it will be better to place a fair amount of money on silver. In the 1970’s bull markets for silver and gold, the silver price rose 3800% compared to 2500% to gold.
Silver is undervalued compared to gold
Industrial uses for silver are abundant, from electrical uses to photographic developments, silver may be one of the most useful metals to man. The applications and uses for the precious metal are always growing. Silver prices per ounce are well behind gold’s. In particular, today for an ounce of gold you need 62 ounces of silver and that is three time higher than in the past, where you could get an ounce of gold with 20 ounces of silver.
Silver is an important diversification and a tangible asset.
Silver like gold, is a precious metal asset and it acts as a hedge against inflation. Silver and gold, are rightly viewed as a safe harbor in times of crisis, therefore, investing in silver is necessary for portfolio diversification. Silver like gold, can also protect against geopolitical uncertainty, unstable economy, and weak currency. Silver like gold, is a great way for an individual to preserve his/her own wealth.
CONCLUSION
Investors from all levels are attracted to silver, as a solid tangible and long term store of value. Nevertheless, silver is heavily undervalued when compared to other commodities, and is also undervalued compared to gold. Many analysts believe silver could be the bargain of the century.
Many economists talk about the gold standard, but very few of us know what is the meaning of the gold standard. The gold standard is a monetary system where the country’s paper money or currency, is directly linked to gold. With the gold standard, the country agrees to exchange money into a fixed amount of gold. That country sets a fixed price for gold, it buys and sells gold at that price. The value of the currency is used to determine the price of gold. The amount of gold the country possess must be equal to the amount of currency circulating.
England was the first to adopt the gold standard and that was back in 1717. The United States followed and by 1880, most countries had adopted the gold standard. The gold standard continued to be part of the world’s monetary system with a small break between the first world war, the great depression and the second world war. It took President Nixon in August 1971 to abolish the rule of the gold standard.
The truth of the matter is people never trusted paper money or even coins. From the ancient times, coins had to be made out of gold, you see gold was the value behind the coin. The first gold coins go back to Asia Minor 3000 years ago.
Today the world operates on fiat currency which is a currency used because the government says so, or because fiat currency must be accepted as a means of payment.
Over the years there has been many voices calling for governments to go back to gold standard. Lately Alan Greenspan the former Federal Reserve Chairman. urges the US government to reform its monetary policy and go back to gold standard. All I have to say is that I agree with him., as a major financial asset and also by investors in order to preserve their wealth.
Nowadays gold is still used by governments and banks, as a major financial asset. Banks also use it as an insurance for loans made to government. Investors too use gold, to preserve their wealth.
Just a few weeks ago Donald Trump became America’s 45th president. Judging by his first two weeks, I can say that his presidency brings uncertainty and chaos. Uncertainty and chaos, are exactly what the markets love to hate. If you add to that the weak dollar, then you have the perfect recipe for gold. You see, the weak dollar and political uncertainty favor gold.
Uncertainty cannot be planned for, cannot be predicted-can only be estimated, and can be wildly and unexpectedly wrong.
The United States economy is the biggest economy in the world, it has the biggest GDP in the world. (16.77trillion) It also has the biggest debt in the world. (17.60trillion)
Because of this difference in size, most people think it’s insulated from the actions of the world economic climate. In addition, the dollar is the world’s reserve currency of choice, and America has been used to have the first word, on many fronts economically.
However, this is about to change.
In recent years, the gap between government income and expenditure has widened due to the degree of military service, and social security commitments, and at the same time, productivity and educational levels, is where its fallen behind.
Without radical change, this gap could reach a point of no return. In this case, the dollar will weaken to a degree unseen in recent years.
At the same time, Russia and China are teaming up in their efforts to replace the dollar, as the world’s reserve currency. And this is possible due to changes in the IMF’s voting system. The BRICS (Russia, India, Brasil, China, and Sth. Africa) have now collectively more votes than the US alone. That means the dollar will soon be in danger unless the Trump administration decides to reform the US financial system.
In addition, when it comes to the US balance of trade, the news isn’t good either. The trade deficit for the year 2016 was $502.25 billion, a 0,4% from the year 2015. This will also weaken the position of the US dollar role, as the world’s reserve currency.
It is imperative that you preserve the value of the things you have and I am talking about your savings. Rather than investing in bonds, shares, and other paper holdings, I suggest that you invest in gold. In this case, when you do come to draw down the money, there will be far more to take. That is the whole idea behind it.
Remember investing in physical gold hedges you against inflation, and protects you if the dollar collapses.
