What is Fiat Money?
British Pounds are issued by decree and are know as Fiat money
Hi Plebs,
Fiat money is a currency that is issued by a government and not backed by any commodity like gold or silver. The value if fiat money is derived from faith and credit of the issuing government, rather than being tied to a physical reserve asset.
The term ‘fiat’ comes from the Latin meaning ‘it shall be’ or ‘let it be done.’ Fiat money only has value because the government maintains that as legal tender and must be accepted as a valid currency for transactions within the countries borders.
How Fiat Money Works
Governments and central banks have the sole authority to issue fiat currencies. As fiat money is not linked to any physical reserve, central banks can increase or decrease the money supply through activities like printing more currency or updating digital ledgers.
The supply of fiat money is regulated by monetary policy decisions around factors like interest rates and reserve requirements for banks. By monitoring the money supply, central banks aim to control inflation and stabilise currencies for use in economic transactions.
Fiat currencies derive their value from a few key principles:
1. Legal tender status: The government declares the fiat currency as legal tender that must be accepted for payments within the country.
2. Adequate money supply: The central bank controls the issuance and removal of currency from circulation to meet economic demands.
3. Stability and trust: People must have faith that the currency will maintain its purchasing power and acceptance as a medium of exchange.
Evolution from Commodity Money
For centuries, currencies were commodity based a derived value from the materials they were minted from, such as gold and silver coins. However, these commodity monies had drawbacks in terms of portability, divisibility for transactions, and maintaining adequate supply.
Paper currencies allowed for greater convenience over commodity monies but were originally just representative money - notes redeemable for the underlying commodity reserve like gold. It was not until abandoning the gold standard that true fiat currencies emerged in the 20th century.
Advantages of Fiat
The key advantages that fiat money provides over commodity based currency include:
Easier to regulate money supply and support growing economies.
Lower costs and risk compared to mining, storing and transporting gold.
Allows central banks to use monetary policy to stabilise currencies and promote economic health.
However, fiat moneys lack of intrinsic value means it carries some significant risks as well.
Risks of Fiat Money
Since fiat is not linked to any physical reserve, its value is subjective and depends entirely on trust. Some of the risks include:
Inflation and devaluation of the currency if the money supply is mismanaged.
Loss of confidence by the public causing rapid declines in the currency value.
Potential for abuse and corruption through money printing and misallocation.
Hyperinflation in extreme cases of economic instability or loss of faith.
Fiat money systems are also vulnerable to economic shocks, poorly designed fiscal/monetary policies, and speculative bubbles that can trigger financial crises or recessions.
Centralised control provides flexibility but also opens the door for potential manipulation. Effective governance with accountability and transparency is crucial to mitigating fiat money’s risk over the long term.
As technology evolves, fiat money will need to adapt to uphold its role as an efficient medium of exchange and store of value alongside any new digital payment systems that do it better.
Cheers, and onwards with Bitcoin
