Thread by @max_gagliardi

1/ How Fiat money works 👇

2/ Over the 20th century the world’s governments moved from a gold standard to a fiat standard. Essentially the government took the power from the banking sector and took over the money

Or the money took over the government, depending how you look at it

3/ Fiat is a debt-based form of money that relies on governments having a monopoly on fiscal and monetary policies. Fiat was created because governments were defaulting on their obligations (debts).

This was the killer use case for fiat. Unlimited debt

4/ Contrary to popular belief, fiat is not “printed”. Fiat money is created through debt, (ie. the promises of payment of future money being as good as existing money), as long as the debt is issued by a government or entity that is granted a lending license by government

5/ Financial institutions “mine fiat” by issuing debt. Government credit allows for future money (that doesn’t exist today) to settle transactions when a loan is made

This allows the borrower and the lender to create more fiat tokens today than before the loan was created

6/ An example is buying a home. The lending bank doesn’t use its cash reserves or use its depositor’s cash. It will simply issue the loan & create the dollars that are used to pay the seller of the home. These are new dollars created by the promise of the borrower paying the debt

7/ Unlike a gold (or bitcoin) standard, the supply of fiat is unlimited, and because there is little differentiation between credit and money, the total supply is practically impossible to measure objectively or audit

8/ The fiat system’s first layer is debt denominated in US dollars

Other fiat currencies (tokens) are 2nd layer networks that trade as a derivative of USD

The approximate value of non-USD fiat is the value of the USD minus a country risk premium

9/ Fiat is a centrally planned system. There is no free market supply/demand that determines interest rates (ie. the cost of capital)

Lending determines money supply, and lending rates are shaped by interest rate and Federal Reserve Policy

10/ Unelected bureaucrats set the federal funds rate, and all other interest rates are derived from this rate

The closer the borrower is to the fed, the lower rate they can obtain. The farther away, the higher the rate.

11/ Central bankers are the gatekeepers to the system, and they have a monopoly over:

1.Backing local currency
2.Settling international trade
3.Backing bank deposits
4.Buying government bonds to fund spending

12/ These functions are very important because they have enormous implications for the drivers of economic growth: capital accumulation, trade, & technological advancement

A system based on gov. controlled central banks essentially puts capital markets & trade under gov. control

13/ The fiat system is very convoluted/opaque and difficult to explain in a Twitter thread. I am by no means an expert on this topic but I find it fascinating

Hopefully this thread gave you a glimpse at the tip of the iceberg

14/ For a deep dive into how Fiat works you should pick up the book this thread was inspired and paraphrased from, the Fiat Standard by @saifedean

It is a fantastic read