Reservation Principle

Fiat money exists to collect seigniorage, which is a sovereign tax on the holding of the money and its money substitutes. The tax is levied by manufacture of the fiat denominated above its production cost. This premium on production is maintained by the monopoly created by anti-counterfeit laws. The objective of the tax is to accumulate political power, including reserve money.

A reserve is the accumulation of a tax hoard. When a state collects seigniorage it must do so in other money not subject to the tax. Otherwise the hoard itself would be diminished by the tax. The issuance of state representative money in exchange for reserve money is a harbinger of fiat, as the state can abrogate the notes at any time. Once the notes are abrogated, the reserve is unaffected by inflation of the resulting fiat.

Initially legal tender laws and taxes create demand for its negotiable promissory notes (notes), which must be purchased with the reserve money. Such laws were applied broadly in the United States in 1862. As reserves accumulate and the notes become widely accepted, the state may seize what remains without immediate risk to future tax on other economic activity. This is done by abandoning redeemability and also sometimes by direct reserve money confiscation.

The United States Federal Reserve Act of 1913 created the current (third) Federal Reserve, giving it the power to issue notes against a monetary reserve, offer discount loans to member banks, and to maintain regulatory control over their money accounts. Domestic abrogation (and confiscation) occurred in 1933 and abrogation was applied to nation-state note holders in 1971. With non-redeemability the notes immediately transitioned to fiat (despite the anachronism of "Federal Reserve Note" that remains on the U.S. Dollar and similarly the fiat of other states).

It is common for the fiat money of one sovereign state to become the reserve of another. This allows the issuer of fiat held in reserve by others to transitively tax holders of lower tier fiat. This tax is begrudgingly accepted by other sovereigns in exchange for the ability to purchase products available primarily in the global reserve. Control over access to the clearing network of the global reserve is often used as an economic weapon. The U.S. Dollar and to a lesser extent the Euro make up the vast majority of foreign exchange reserves.

Electronic money is harder for third parties to counterfeit, and gives the issuer visibility into all financial transactions. This visibility offers another opportunity to tax via the money, as it facilitates enforcement of various taxes. Avoidance of these takings is referred to as tax evasion or money laundering by the state, depending on context. As such we are witnessing the gradual disappearance of tangible money. Fiat may initially be constrained to vaults and may eventually exist only in electronic accounts controlled by the state, with automated clearing of member bank money accounts.

The only brake on the inflation of fiat is the inability or unwillingness of people to pay the tax. This results in abandonment of the money despite legal tender laws. As this takes hold the sovereign typically enacts foreign exchange controls to raise the cost of using alternate monies, though such controls can have high enforcement costs. Eventually fiat goes completely out of use and the reserve money is utilized by both individuals and the state.

With the inability to tax at sufficient levels comes consumption of the reserve. This is a currency crisis, caused by a sovereign debt crisis, likely resulting in a political crisis. With the establishment of a new money and/or sovereign the cycle continues.

As most global reserve is in fiat, a failure in the reserved fiat will propagate through all state monies. Such a failure can be mitigated neither by transition to another state's fiat nor gold and/or silver. Trade is largely electronic and metals do not travel over computer networks. In other words, Bitcoin is the only money that can resolve a currency crisis in the modern global reserve without a catastrophic global contraction of trade.

As shown in Reserve Currency Fallacy, if Bitcoin was to become primarily a reserve currency for clearing state money substitutes it would cease to be Bitcoin. However it will always be possible to continue it apart from the state, and people may better defend it after learning from past failures.