Reservation Principle

Fiat money exists to collect seigniorage, which is a sovereign tax on the holding of the money. The tax is levied by manufacture of units of the money denominated above its production cost in the money (i.e. counterfeit). The objective of the tax is to accumulate political power, including reserve money.

A reserve is the accumulation of a tax hoard. When the sovereign state collects seigniorage it must do so in another money not subject to the tax. Otherwise the hoard itself would be diminished by the tax. The existence of a reserve presupposes fiat, as otherwise there is no reason for two monies. The reserve retains its value despite the purposeful debasement of fiat, and is eventually held primarily by the sovereign. The current (third) United States Federal Reserve was instituted in 1913.

Initially legal tender laws and taxes create demand for fiat, which must be purchased with the reserve money. Such laws were applied broadly in the United States in 1862. As reserves accumulate and fiat becomes widely accepted, the sovereign may seize what remains without immediate risk to future tax on other economic activity. This is done in part by abandoning fiat-reserve convertibility and also by direct confiscation. In the United States domestic confiscation and non-convertibility occurred in 1933 and non-convertibility was applied to nation-state fiat holders in 1971.

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 US Dollar and to a lesser extent the Euro make up the vast majority of foreign exchange reserves.

Fiat is typically "paper" and/or metal currency used alongside account-based money. Since issuance is the source of taxation, money accounts, now largely electronic, are brought under control of the sovereign. As such, fiat issuance is primarily electronic yet euphemistically referred to as "printing" money. This occurred in the United States in 1913, coincident with creation of the reserve system. With the Federal Reserve Act the state gained physical control over a national reserve, the power to issue notes against it, and regulatory control over money accounts.

Electronic money is harder for third parties to counterfeit, and gives the issuer visibility into all financial transactions. This visibility is another tax on users of the money, as it compels increased compliance with independent takings. 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 paper and metal money.

The only brake on the counterfeit 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 sovereign.

With the inability to tax at sufficient levels comes consumption of the reserve, which was ultimately insurance against the failure of the fiat. 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 sovereign'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.

Because people can mine and accept Bitcoin covertly and globally, it will be difficult for states to collect it into a reserve, which stands to break the cycle. This is ultimately the promise of Bitcoin. As shown in Reserve Currency Fallacy, if it was to become primarily a reserve 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.