Since fiat currencies, per se, are not redeemable for anything other than themselves, their very existence depends upon confidence. The issuing authority must not inflate the currency’s size to the point that it begins to lose purchasing power in the market at an abnormal rate. As long as the public is willing to hold the currency, its purchasing power need not depreciate at a noticeable rate. But once the public reaches its limit as to how much currency it deems necessary to hold for daily transactions and to have a ready amount for unanticipated other spending, any further expansion of the supply will threaten its acceptance as a medium of exchange.
One can see the danger. Unlike the case of a gold-backed currency, there is no objective way to measure when a fiat currency has been over issued until its purchasing power falls very quickly. At that point the monetary authorities may have lost total control. Even if they cease monetary expansion and perhaps even shrink the money supply, the currency may be doomed. Its purchasing power drops to zero (i.e., the public wants to get rid of the currency for almost any durable goods). This is the risk that threatens the US dollar today.
True, the dollar is still accepted widely, but there are indications that the public is losing confidence in it, especially outside the US. US residents still demand the dollar in order to conduct daily commerce, but this is not so outside the US. Foreign holders of the dollar do not pay their utility, grocery, and other bills with dollars. They use local currencies. The dollar’s foreign demand stems from settling international trade accounts in a unit that is widely accepted worldwide and also for investments, such as in short term US Treasury bills. But when the purchasing power of the dollar drops faster than the interest rate paid on Treasury bills, foreign investors lose money. Raising the rate paid on these bills may not solve the problem, because foreign investors may rightly see the danger that the dollar’s purchasing power will drop faster and faster, possibly to zero!
Austrian School economists, as opposed to Keynesian economists, understand that this is a function of human action and not mathematics. There is no mathematical way to determine when confidence will be lost. It can be precipitated by large or even small actions. The war against Iran is one such large action, but the steady drip, drip, drip of decades of budget deficits can do the same. Even before the horrendous cost of the Iran war added to the budget deficit, the US deficit was running into trillions of dollars annually. Just this year the total US debt passed forty trillion dollars, an immense amount that no one really expects will ever be settled honestly (i.e., not inflated away with dollars of less and less purchasing power).
Perhaps the final straw that will break the dollar was the incredibly preposterous promise by President Trump to give every adult American $5,000 if his party retains control of the legislature after the midterm elections in November. Depending upon the exact definition of “every adult American,” this will amount to over another trillion dollars added to the already out-of-control deficit. Would it be any wonder if foreigners start perhaps not so quietly trying to sell their dollars for whatever they can get? If so, Americans will not be far behind.
