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Fiat Currency: All One Needs to Know

This article is dedicated to the idea of ​​fiat currency and what is behind this idea. What is fiat money? When and what was it published for? What is its value? What are the pros and cons? Find answers to these questions and more in the following article.

What is fiat money

Fiat money is the bills we keep in our wallets and the sums of money we happily look at when we log into our bank's mobile app on our smartphones. It is not backed by the country's gold reserves or other precious metals. It has no internal cost and its face value is set and guaranteed by the state.

Today, almost all major currencies such as dollars and euros are fiat. Their value derives from their ability to be exchanged for goods and services that serve as a means of savings and a unit of account for the country's economy.

Some argue that as long as fiat money is not tied to goods, there is a risk of inflation, which in turn makes goods and services more expensive. Under the gold standard, for example, the supply of money depended on the amount of wealth in the country's reserves: more gold, more money.

Fiat money is significantly influenced by local demand and trust. If they stop believing in the national currency, they will reject it, and demand for other assets and currencies will increase.

A gold-backed currency has an internal cost due to the demand for the precious metal. Gold prices can fall, but the currency implies that it will be exchanged for the metal. In addition, the price of gold has increased practically sevenfold in the last 20 years.

When fiat money appeared

The first coins made of precious metals appeared in China: this money was maintained by the army and collected as taxes. However, the demand for coins began to outstrip the quantity of metal itself, prompting people to switch to banknotes.

Some say that money was used in Rome as it is used now. Roman civilization was one of the greatest in the world and its decline happened due to an imperfect economy and huge inflation provoked by the emperor. He ordered money to be made out of lead instead of precious metals. Experts say it was in fact fiat money.

In modern history, the US once attempted to peg the dollar to gold, but the idea was abandoned as early as 1971 because gold reserves were quickly depleted. Exchange rates were no longer fixed and began to depend only on supply and demand.

Advantages of fiat currencies

Fiat money is used to exchange and store value, which is essential for the functioning of the national economy;
Making fiat money is more economical than pegging currencies to specific assets;
Fiat money allows the government and central bank to boost the economy in times of crisis and smooth out the aftermath of the boom;
Fiat money is not a scarce or finite resource: the government can print as much as it needs;
Central banks have full control over the supply of fiat money, allowing them to manage liquidity and interest rates.

Disadvantages of fiat money

The severe economic crisis of 2008 showed that central banks cannot always stop the serious consequences of a recession by directly regulating the money supply. Therefore global crises will come back from time to time and be of a completely different nature.

A gold-pegged currency looks more stable compared to fiat money due to the limited supply of gold. In contrast, fiat money has value as long as the government backs it. The smallest problems in the economy and politics can trigger a surge in inflation.

There are examples of trying to get out of economic troubles by actively printing money, leading to hyperinflation and a complete devaluation of the national currency.

Fiat money is not perfect as it has serious disadvantages, but there is no better alternative that would quickly and smoothly replace it as a medium of exchange, payment and store of value.

One could address cryptocurrencies that have recently gained popularity. They are limited in quantity, their cost must increase until the last coin is mined, and this is a victory over fiat money inflation. However, due to the high volatility and virtuality, this type of money has not yet become a full replacement for “normal” money.

Even experiments with a fixed link between money and gold have not yet produced satisfactory results; and hyperinflation can occur with any printed currency. However, with all its disadvantages, fiat money allows the government and central banks to react in time to the Ver