REPRESENTATIVE MONEY
Money that represents an intrinsic form of money is ‘representative money’. Representative money differs in physical form and has less intrinsic value than the form of money it represents. Using representative money, the intrinsic form of money may be redeemed on demand.
Example
Assume [1] rice is the societal form of money and [2] the Monetary Unit is a fixed volume of rice – one cup.
Raiders from afar have emerged who rob farmers of their stored rice, so farmers decided to store their rice in a shared facility, structurally fortified and protected. Each farmer brings his harvest to the shared facility, the harvest is volumed, and each farmer is issued paper currency representative of the total cups delivered. On demand, any holder of the paper currency may go to the facility and receive the stated amount of rice in cups. Paper currency becomes the circulated form of money, replacing rice. Societal changes occur to accommodate the movement of the new form of money.
Monetary Management
In the example, the Monetary Unit is stated to represent a fixed volume of rice; however, the paper currency does not represent the specific rice for which the paper currency was originally issued since the rice of one farmer has been intermingled with the rice of other farmers in the storage bin. Some rice may spoil in the storage bin; however, paper currency does not spoil and worn currency is reissued.
The actual worth of the Monetary Unit equals the total amount of usable stored rice divided by the total amount of issued paper currency. If one cup of rice spoils in storage, then the actual value of a unit of paper currency is something less than its stated value of one cup. If there was a run on the facility, those units of representative money that cannot be redeemed on demand are actually units of non-representative money – fiat money. Representative money has to be actively managed to insure that the variations stay within reason, to maintain confidence in the currency in order to prevent a run on the facility.
FIAT MONEY
When there are more Monetary Units of representative money in circulation than Monetary Units of the original form of money in reserve, then the excess representative money is fiat money – it has no foundation of value.
Reserve Ratio
A reserve ratio of 1:1 implies that the amount of the original form of money in reserve equals the issued amount of representative money. By reducing the reserve ratio below the value of one, fiat money increases. There is nothing sacrosanct about a fixed minimum reserve ratio. The Bank of England, before Peel's Act of 1844, maintained a 33 per cent gold reserve against notes and deposits. By continually ratcheting down the reserve ratio, the more fiat money is created.
Eventually, the reserve ratio approaches zero, and all money becomes fiat money, no longer redeemable. Since fiat money has no foundation of value, the perceived value of fiat money can drift. Managing the value of fiat money is intricate when there is no rooted value.
Issuance of Fiat Money
In the
