The Law of Reflux
The law of reflux is explained using an example of backed money. In the example, government-issued money is backed by the government’s assets (mainly taxes receivable) while bank-issued money is backed by the bank’s assets. The value of both kinds of money is determined by the amount of backing held per unit of money issued. The example shows that reflux maintains money’s value, not by assuring that excessive issues of money reflux to their issuers, but by providing people with access to the assets backing their money. Conventional metallic convertibility is only one channel of many through which money can reflux to its issuer. The suspension of metallic convertibility still leaves many other open channels of reflux, but can create the illusion that money is unbacked fiat money that was somehow forced into circulation. Backed money will hold its value as long as its issuer remains solvent. One way for an issuer to stay solvent is to issue money in exchange for short-term real bills of adequate value, but as long as the bills are of adequate value, it is largely unnecessary for the bills to be real or short-term.
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- Michael F. Sproul, 2003. "There's No Such Thing As Fiat Money," UCLA Economics Working Papers 830, UCLA Department of Economics.
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