What Happens When a Currency Fails?

As I expected, my last column where I raised the question whether it would really be so bad if the US dollar failed brought on a storm of comments.  Along with many thoughtful points, there were some comments from people who just didn’t think through the implications of my question.

Perhaps another story from history and then a look at how people in two nations are today coping with troubled currencies will provide more light on the subject.

The failure of the Continental dollar in the Revolutionary War deeply scarred the national psyche.  As a result, the US Constitution specifically prohibited any state from making anything but gold or silver legal tender in payment of debts.  Though paper currency was common in most European nations by then, the US government did not issue any paper money until the beginning of the Civil War, 74 years after the Constitution was written.

This issue of unbacked paper money (called Greenbacks) to help finance the Union’s cost of pursuing the war was advocated by Treasury Secretary Salmon P. Chase.  The lawsuits contesting the legality of the US government issuing unbacked paper money did not reach the US Supreme Court for several years.  When they did, it happened that Salmon Chase was then one of the justices serving on the Court.  Initially, Chase voted with the majority to affirm that his actions to issue unbacked paper money was unconstitutional.  After President Grant appointed two new judges, the new majority ratified the legality of paper money issues, though Chase still voted that his own actions in the Civil War were unconstitutional.

Even as Americans were legally required to accept Greenbacks as legal tender, it didn’t work smoothly in California.  Though these notes stated that they were acceptable for payment of import duties, even Customs officials in California did not like receiving them.  Until well into the 1870s, any Californian who forced a merchant to accept paper money instead of gold in payment would find that merchants would thereafter refuse to do business with him or her!

To help the public accept US government paper money, the Treasury began issuing Silver Certificates, redeemable for silver dollars, in 1880 and Gold Certificates, redeemable for gold coins, in 1882.

Now let’s discuss the falling paper money values in modern-day Vietnam and Iran.

Vietnam’s inflation of the paper money supply has been such a problem for the past several years that citizens in that country have to use gold for payment when purchasing real estate.  Although the government technically prohibits posting of prices in gold, buyers have learned that sellers will only sell if they receive gold.

The country of Iran is going through severe problems with a declining fiat currency.  In just the past month, the Iranian rial has fallen about 1/3 against the US dollar.  This is causing an enormous disruption in the economy.  The government’s official policy there is to discourage transactions priced in US dollars, but the citizens, as much as they dare, are switching to using US dollars, gold, or consumer goods to preserve the wealth.

The Iranian government has already banned foreign exchange businesses from dealing in US dollars.  In the past week, the government has started to crack down on the black market currency traders who might be dealing in US dollars.

The Iranian rial has not failed–yet.  However, in the past month the imports of goods into the country have ground to a virtual halt as sellers are unwilling to accept rials in payment.  Citizens are aggressively withdrawing their funds from bank accounts that are paying 17% interest to convert them either into US dollars, gold, or consumer goods.

The important point is that even though the Iranian rial has not yet failed, the public is adjusting their spending habits and their means of storing wealth.  Former exporters to that country have already switched to accepting payment in alternative currencies.  In the process, there are some severe economic disruptions, many of which are caused by government efforts to prevent citizens from taking steps to protect their financial well-being.  However, should the rial eventually collapse, that event will be less traumatic because those affected by it will be well on the way to using alternative monetary systems.

That is the key point to understand should the US dollar eventually fail.  In reality, the US dollar is following down the path towards collapse, just like the Iranian rial.  Long before the dollar crashed, there would be greater economic turmoil in this country as people sought to protect their wealth by abandoning dollars for stable assets like gold, silver, and consumer goods.  The process will be made even worse to the extent that the US government tries to interfere with people peacefully serving their own self-interest.  There will be civil unrest.  And I do expect the American standard of living would decline. All of this will develop before the dollar fails.  The actual event of the failure of the US dollar will not be very important.

However a dollar crash could bring on an opportunity for people to adopt a stable monetary system beyond government interference, which could form part of the base to regrow the economy.  Although there is no magical reason why they should, I expect that the multi-thousand year track record of gold and silver as a safe haven asset will result in them becoming a major component of any stable monetary system.

An important follow up issue is whether the US dollar and economy are too far gone, making a collapse inevitable.  Sadly, I think it has.  But that is a subject to discuss another day.

Patrick A. Heller owns Liberty Coin Service in Lansing, Michigan and writes “Liberty’s Outlook,” a monthly newsletter covering rare coins and precious metals. Past issues can be found online at http://www.libertycoinservice.com/ Pat Heller is also the gold market commentator for Numismatic News. Past columns online at http://numismaster.com/ under “News & Articles”. His bimonthly columns on collectibles can also be read at http://www.lansingbusinessmonthly.com under “Articles” and “Department Columns.”His radio show “Things You ‘Know’ That Just Aren’t So, And Important News You Need To Know” can be heard at 8:45 AM Wednesday mornings on 1320-AM WILS in Lansing (which streams live and becomes part of the audio and text archives posted at http://www.1320wils.com.