This why we need fiat money

Libertarians and the libertarian wing of gold and cryptocurrency enthusiasts love to hate central banks and paper money issued by them. They constantly argue that the issuance of paper money that is not backed by gold or some other limited resource leads to inflation and potentially hyperinflation. Probably the most prominent example of this line of argument is the book “End the Fed” by former US Representative Ron Paul. Amazon now provides us with an opportunity to see what happens when libertarians get their way in terms of abolishing the Fed and fiat money.

The company recently launched its massive multi-player online role-play game New World and accidentally turned it into a simulation of an economy without a central bank. Well, what the company did was provide a limited supply of money in the game that could not be increased as more people were coming online to play the game. If that sounds familiar, it is because that is exactly the idea behind backing currency with gold or the limited supply of bitcoin, for example.

As more and more players joined the game, the demand for money increased rapidly but the supply did not change. So money became more and more valuable. That’s great if you own some of that money, but not so great if you are trying to make a living because it means that it becomes more and more difficult to get your hands on the money with which to buy stuff. In fact, a variation of Gresham’s Law tells us that as the money in the game becomes more and more sought after, people should start hoarding their cash with the expectation that it will become even more valuable in the future. And that is exactly what happened in New World. Players were hoarding cash.

Now that may seem innocent enough but what it meant was that it became harder and harder to buy raw materials with which to make things because one needs to have cash to buy these. Meanwhile, goods and services that can be made by individual players became cheaper and cheaper. The reason is simply that if you are unable or unwilling to get your hands on money, you try to make money by producing stuff and then selling it to other people. But as more people produced stuff and fewer people were willing to spend their valuable money, the prices of these goods dropped dramatically. The economy of New World dropped into deflation. Within days the deflation became so severe that people were resorting to barter, offering 1,000 linen for 600 ore and 20 eggs, just to get their hands on crucial raw materials and food because they didn’t have the money to buy them otherwise.

The problem of New World is simply that the supply of money is limited while the demand for money grows as the population grows. In the real world, the same would happen if we went back to a gold standard or adopted cryptocurrencies as legal tender. It would obviously happen much slower because population growth in reality is smaller than in Amazon’s game, but it would happen nevertheless. That is simply the effect of mathematics and the law of supply and demand.

So, for all those people out there who advocate a return to the gold standard or for cryptocurrencies as the new gold for the digital age, I suggest you play New World to see what kind of new world you are advocating for. I, for one, prefer a world of central banks and fiat money where the supply of money can grow in line with the demand for it.