Fiat Value

By Steven J. Grisafi, PhD.

The intrinsic value of any sovereign currency, regardless of its basis, is the law which binds all citizens of the sovereign nation to use the currency to pay their taxes. This holds true whether or not the government issuing the currency seeks to base it upon some commodity, such as a precious metal, or to seek to adjust the value of their currency by controlling its future value relative to the present. Usually, this second method of setting value is accomplished through the manipulation of rates of interest promised to be paid with said currency. When this promissory mechanism is used the currency is referred to as “fiat”, Latin for “let it be.” Regardless of how a government may choose to base the value of its currency, that value ultimately depends solely upon the usage of the currency by its people. However, others, besides the citizens of the sovereign nation issuing the currency, people who are not obliged to pay their taxes using any such currency, must also see value in the currency issued by a sovereign nation different from their own. Otherwise such persons would not accept the currency as payment in exchange for goods or services they provide in trade. Consequently, unless a nation is autarkic, its currency must be seen to have value to persons not obliged to use it.

It is this obligation, or lack of obligation, to use a currency which stymies the efforts of central banks to insure value for their currency. If nobody is required to use a particular currency its only salvation is to become desirable such that people choose to use it. This is the aspiration for the promulgation of various crypto-currencies. Historically, all currencies were valued as commodities. Salt was use to preserve food and the noble metals where used to craft utensils and other instruments. In modern times our abandonment of a gold standard for currency has meant that the people of any government issuing such fiat currency must be capable of producing goods or services that other peoples want to buy. Oftentimes, the only hope for doing so is to sell at a price lower than domestic production can sustain. Although doing so may sustain trade, it may also produce significant hardship.

Our task is to find a means to enhance the stability of a currency regardless of how the central bank issuing it chooses to insure its valuation. When conducting trade between nations possessing different currencies, merchants would usually consult the pair-wise exchange rate between two differing currencies. This pair-wise exchange rate is a dynamic quantity fluctuating in value with the passage of time. Any trade would occur at the exchange rate at the moment of transaction. If it could be imagined that the cost of currency exchange were negligible then the direct exchange of one currency for another using the dynamic pair-wise exchange rate may not be the most cost effective procedure. When one recognizes that exchange to other alternative currencies is also possible, a direct exchange may not be the most fortuitous from the prospective of either buyer or seller. Recognizing that there exists a universe of alternative currencies with which one may exchange one’s currency a measure of stability of any given currency needs to define any possible alternative paths toward acquiring one currency from the exchange of another. If there should exist any such thing as an equilibrium exchange rate it can only be evaluated in the presence of any alternative exchanges that may be possible.

Determining which factors are the most significant players acting upon the environment of an equilibrium condition poses the greatest challenge for finance rheology. We have observed that sovereign currency exchange rates exhibited less instability when all currencies were measured relative to the Basecoin than for the Bitcoin. However, even when a Basecoin basis is used, there is still much more instability than when the United States dollar is used as the basis for a universe of exchange rates. It is understandable from which this enhanced stability provided by a US dollar basis derives. Undoubtedly, it is a reflection of the stability of the government and economy of the United States itself. Yet the US dollar is still only a fiat currency whose value is secured solely through the promissory method of contrasting present and future values. Surely, there are limits beyond which the promissory method cannot function. Consequently, we seek now to evaluate stability of currency exchange rates with a basis having intrinsic value.

As best one can surmise, what basis would provide intrinsic value to a set of currencies, the most likely candidates would be the precious metals gold and silver. Using the spot price of gold and silver taken daily for the Japanese Yen, Pound Sterling, and the Euro dollar we examine the diffusion equilibrium conditions for the pair-wise exchange between the Pound Sterling and the Euro dollar. The calculation details are presented in a white paper to be found here. After approximately one year of daily values the Bitcoin basis diffusion analysis yields at least two equilibrium states, one with a value of 0.968 Pound Sterling that can be purchased with one Euro and another with 0.136 Pound Sterling for one Euro. This is to be contrasted to the arithmetic average pair-wise exchange rate for the two currencies over the same time period as 0.888 Pound Sterling for one Euro. Preliminary results for the intrinsic value analysis are encouraging. After only ten days of data the gold basis yields one equilibrium state with 0.85 Pound Sterling per Euro and another with 0.11 Pound Sterling for one Euro. After ten days the values of the exchange rate for the silver basis are still fluctuating significantly. The silver basis yields one equilibrium state at 0.83 Pound Sterling per Euro and another with 0.23 Pound Sterling for one Euro. These equilibrium states are to be compared to the arithmetic time average over the same ten days of 0.88 Pound Sterling that can be purchased with one Euro for both precious metals. Clearly, ten days is insufficient time to evaluate the equilibria. Yet, the precious metals do seem to be stabilizing quickly. We continue to evaluate this analysis.

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