Fiat currency definition
Fiat money is a currency that is issued by a government and is not backed by physical commodities such as gold. The US dollar, the euro, and the pound are examples of fiat money.
Could you imagine having to carry gold with you shopping your groceries for the week? Earlier in history, people used gold for goods and services rather than the paper money we are all used to today. But now, instead of gold, we are using currencies like the US dollar, the euro, and even cryptocurrencies in exchange for products.
There are different types of currencies these days – some can be government supported, such as fiat currencies, and others are decentralized and supported by blockchain technology, such as cryptocurrencies. This article explains the answers to «What is a fiat currency», their advantages and disadvantages, and how they differ from other currencies.
What is fiat money?
Fiat currency, or fiat money, is a currency that is issued by the government and is not backed by physical commodities such as gold. Instead, fiat money value comes from the public’s trust in the issuer, the government.
Why is it called fiat currency? The Fiat definition comes from a Latin word translated as “let it happen” or “let it be”. Fiat money only has value because the government assigns it a value and therefore has more control over the currency and how much can be printed.
Fiat Money vs. Cryptocurrency
Fiat money is legal tender, a currency that has been declared legal by the government and the value of which is secured by the issuer (the government). On the other hand, cryptocurrency is a digital currency that is backed by blockchain technology and is decentralized, which means that it is not backed by a central authority such as a government.
In contrast to fiat currencies, a cryptocurrency is more volatile and offers a higher level of information security compared to fiat money. Although some people believe that cryptocurrencies could replace fiat currencies in the future, most transactions around the world are still made with fiat money.
Fiat Money vs. Commodity Money
Commodity money has intrinsic value, that is, it is perceived or true value. This type of currency is derived from a material that has some value, such as gold or silver. Fiat money, on the other hand, has no intrinsic value. Consider dollar bills – they are all cut from the same paper, but their value can vary depending on what a government deems fit to be exchanged for the currency.
Fiat currency vs. representative money
Representative money is also produced by the government, but unlike fiat money, it is backed by a physical commodity. There are several forms of representative money, such as credit cards and checks, that represent payment intent.
Although fiat money is government backed, representative money can be backed by a variety of assets. In the case of a check and credit card, they are covered by the money in a bank account.
Understanding Fiat Money in the United States
For most of US history, the national currency was backed by gold and silver. In 1933 the government passed the Federal Reserve Act in hopes of restoring public confidence in the national financial system. This bill would develop a program to rehabilitate banking facilities and later abandon the gold standard, which allows citizens to exchange currency for gold. From then on, the gold standard was completely replaced by fiat money: the US dollar.
Advantages and disadvantages of fiat money
Just like other currencies, like cryptocurrencies, there are some advantages and disadvantages to fiat money.
|Advantages of Fiat Money||Disadvantages of fiat money|
|More control over the economy||Not a foolproof way to protect the economy|
|Inexpensive to manufacture||Possibility of hyperinflation|
|Convenient to use||Unlimited supply could create economic bubbles|
Advantages of Fiat Money
Fiat money is not only inexpensive to produce, but also easy to transport and exchange. But one of the greatest advantages is that fiat money is not backed by a commodity, which means that unlike gold, it is not scarce. Because of this, a government has greater control over the supply of currency, which gives it the power to control economic variables such as interest rates, liquidity, and credit supply.
Since a government is in control of the money supply, it also has the power to protect the country from a financial crisis. In fact, the US Federal Reserve has a dual mandate to keep the unemployment rate and inflation rate low.
Disadvantages of fiat money
Although a government is in control of its foreign exchange supply, it is still not a guaranteed way to protect the economy from a financial crisis like a recession. Another downside to fiat money is that it is subject to inflation and a government may mismanage it and print too much money, which could lead to hyperinflation.
In addition, the price of fiat money depends on government regulations and fiscal policies, which could lead to a bubble with a rapid rise and fall in prices.
The future of the fiat currency
Almost every country has fiat money as legal tender, so it’s hard to say what will be put on hold for the future. Although there is a rapid surge in cryptocurrencies – and some experts believe it could eventually replace fiat currency entirely – fiat money gives governments more flexibility in managing a country’s economy.
Sources: GOBaking prices | History of the Federal Reserve
Frequently asked questions about fiat currency
Here are some common questions about fiat currency.
What are alternatives to fiat money?
Today almost all countries have fiat money as legal tender. Although gold coins could be an alternative to fiat money because you can buy and sell them, they are not widely used for everyday shopping.
Cryptocurrency is another fiat money alternative that is on the rise. Cryptocurrencies like Bitcoin could be used as the main form of currency in the future, but are not yet widely accepted.
Why do modern economies prefer fiat money?
Due to the limited amount of gold that came out of the mines, central banks could not keep up with its new value. Fiat money was the alternative that was inexpensive to produce and convenient to use, and gave the government more flexibility in managing its own currency.
Does fiat money lead to hyperinflation?
Although overprinting fiat currencies could lead to hyperinflation, most developed countries typically experience moderate inflation. Hyperinflation has even occurred in commodity money in the past and could occur when a fiat currency quickly depreciates in value, such as when people lose confidence in the local currency.
Why is it called fiat currency?
Fiat currency is derived from a term translated «it should be» in Latin and refers to a type of currency issued by the government that is not backed by physical commodities such as gold. The US dollar, the euro, and the pound are examples of fiat money.
Is Bitcoin a Fiat Currency?
Bitcoin is not a fiat currency as it is not legal tender by the government. Bitcoin is a cryptocurrency that is supported by blockchain technology and has no central authority.
Examples of fiat currency
Some examples of fiat currencies are:
- US dollar (USD)
- Euro (EUR)
- British Pound (GBP)
- Korean Won (KRW)
- Japanese yen (JPY)
- Indian rupee (INR)
- Mexican Pesos (MXN)