What is Fiat Money?

Published by Thomas Herold in Banking, Economics, Laws & Regulations

'Fiat Money' is explained in detail and with examples in the Economics edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Fiat Money proves to be money that has no real intrinsic, or actual, value. It instead derives its worth from governments accepting it as legal tender. The concept of fiat money on a large scale is a relatively new one. Throughout practically all of history, the majority of currencies around the world derived their value from silver or gold. Fiat money is instead entirely based on trust and faith in the issuing monetary authority.

The problem with fiat money lies in the ability of the governments to inflate its value away. They can do this by over printing it. Since fiat currencies are not restricted by a requirement of hard reserve assets, they can be created in any quantity that the issuing government desires. As the supply continues to rise while the demand remains constant, its purchasing power will fall. When the supply is drastically increased, then hyperinflation will result. Fiat money that falls by hundreds of percent in value is deemed to be a victim of hyperinflation.

The other disadvantage is that only peoples’ trust in it ultimately gives it practical value. It suffers from inflation and finally hyperinflation, then the confidence in it becomes shaken. Fiat money that lacks the confidence of its citizens will finally collapse in value and then no longer be of any trading use for daily transactions. When it fails, people either return to barter systems, or the government establishes a currency based on hard assets once again.

The history of money has proven on a number of occasions that governments debase currency to the point of fiat money when it suits them. They do this because it allows them to print as much as they need to pay for things. While this creates inflation for their citizens, it gives the money issuing government the ability to repay their debts with cheaper fiat money. Finally, as a society has had enough of the devalued money and currency instability, they force the government to return to asset backed money. This has happened before, and some monetary experts say that you are starting to see this happen again nowadays.

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The term 'Fiat Money' is included in the Economics edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.