What is fiat money?

What is fiat money?

Table of content:

What is fiat money?
– Basic concepts
– What is fiat money term history?
– A few examples from the history
– Other noteworthy moments

 What is fiat money? It is well-known that commodity exchange originated very long ago – in the era of antiquity, long before the appearance of the first books and chronicles, becoming a natural consequence of the division of labor. Centuries passed, civilization developed gradually, so humankind came to the appearance of monetary systems. The last ones included the use of coins, which were minted from gold, silver and other valuable metals.

Everything would be just fine, except for one thing: the shortage of materials required for the manufacture of the above mentioned banknotes. This problem was solved by the financiers of the past by the invention of paper money – banknotes, at first provided with the resources of the state. However, over time, the nominal value of currencies began to differ from the real – due to the growing shortage of their gold equivalent. So money became fiduciary or fiat.

Basic concepts

So what is fiat money? It should be noted that the name fiduciary money, came from the Latin word “fiducia”, meaning “trust”. These means of circulation have become so called because they do not have a supply of precious metals, and their value is supported by people’s confidence in their value. The payment means of such money are made by state, obliging its citizens to take them at the declared nominal value.

As for the term “fiat money”, at present it is completely identical to the one considered above. Its emergence, it owes Americans who first used it at the end of before last age. Like fiduciary money, fiat money is also unable to “boast” of an intrinsic value equal to the nominal value. They are in circulation on instructions from above, fully relying on the authority of the current authorities, which is confirmed in their name (the word “fiat” in Latin means “so be it”).

Based on the above points, you can make a simple and simultaneously meaningful conclusion. Provided that the power of authority is reduced, the purchasing power of fiduciary money regularly falls too, and prices in the country are increasing. In addition, in such situations, there is a so-called “flight from money” – a phenomenon the essence of which boils down to the search for ways to get rid of devalued banknotes. The last one is manifested through the acquisition for this money of certain material values – real estate, technology, jewelry, etc.

It is also noteworthy that previously there was a difference between fiduciary and fiat means of circulation, manifested in the following:

  1. The fiduciary money was the money that issuers undertook to repay with different goods that had value – for example, gold.
  2. Fiat money, in principle, were not provided by goods. Most often, the place of wealth is occupied by debt securities.
  3. In spite of the fact that fiduciary money was extremely rarely provided for 100%, the owner could fully expect a certain repayment.

However, gradually providing such money with commodity values – even partial – became a bit faded. A characteristic manifestation of this was the decision of the US Federal Reserve to abandon the idea of paying the cost of circulating banknotes at the request of the bearer, dated 1963. Since that moment, the American currency has become a fiat money, staying in this status so far.

What is fiat money term history?

Historically, the concept of fiduciary money is primarily connected with Britain. It arose in the turbulent era of modern times, becoming a natural consequence of the organization of the circulation of banknotes, carried out with the Bank of England. Initially, the last ones acted as bills that used the peg to gold coins in a full ratio – 1 to 1. However, subsequently, the British financial system was unable to support this principle. The reason was an intensive growth of capitalist relations, demanding more money than all actually existed. So the Bank of England began to issue banknotes, the gold supply of which was inadequate. In order to control the issuance process, in 1844 a corresponding act was issued – Peel’s Acts, in effect transferring the right of issue of the national currency to the Bank of England.

More than hundred years have passed, and the last system of the gold standard – the Bretton Woods – first found itself in a state of severe crisis, and then collapsed completely. It happened in the early 1970s – after the United States was forced to finally give up the issue of gold at the first request of central banks of other states. Significantly changed and the composition of the mass, classified as fiduciary system. To date, it includes bank cards and some other types of carriers a purchasing power of which depends on the strength of the country’s economic system and confidence in the issuer.

A few examples from the history

Talking about fiat money, it should be noted that as such they appeared long before the introduction of the term attached to them into the scientific circulation. There are several confirmed examples of mass use of such circulation facilities, the list of which is presented below:

  1. For the first time paper banknotes appeared in the 7th-8th centuries of our era. Their homeland was China, which at that time was ruled by the legendary Tang dynasty. Most researchers believe that the money was also fiat as well as during Song dynasty in X century.
  2. Another characteristic example is the Follis – a coin of the Roman Empire, which the Emperor Diocletian required to assess above its real value. The Governor even issued an edict, according to which all those who refused to accept this base coin were subjected to severe punishment – up to the death penalty. True, the emperor did not succeed in achieving the desired goal, and his successors preferred to abandon such initiatives.
  3. It is also known that on the territory of the possessions of the British Crown in North America, which later became the United States, there were so-called Colonial money, not burdened with debts. They had no real value, and their value was based on the adopted legal norms that define these means of circulation as payment. And we must admit that this project was truly successful – to the extent that the Metropolitan, which was in dire need of the receipt of precious metals from its colonies, had to cancel it.

By 1914, on the eve of the clash of world empires, the currencies of the leading states of the planet could be converted into gold. In the future, such ability of these means of circulation was minimized, and now national monetary units are not provided with goods of value in the overwhelming majority of cases. As mentioned above, the strength of such money is based on the power of authorities, obliging them to accept them as an approved means of payment.

Other noteworthy moments

What is fiat money role today? Despite the fact that the first creators of the currency were Chinese – at first they called it “flying money”, speaking about it rather disdainfully, now their “child” has become the most widespread around the globe. And we must admit that this is quite natural, because precious metals, originally used as banknotes, are clearly not enough to meet the needs of modern economy. For some time, the problem tried to solve the damage of currency and coinage from less expensive materials. However, this initiative only delayed the mass distribution of paper money, most of which became fiat- not having commodity security.

Based on the statistics, we can say that in the United States, the total amount of fiduciary funds exceeded the total mass of standard money by more than 7 times 10 years ago. Thus, the degree of significance of the fiat means of circulation is truly impressive, and it is almost impossible to overestimate it.

Electronic currencies of the category considered in this material deserve a special mention. So, artificial digital means of circulation are characterized by the following features:

  • expression in one of the state currencies;
  • almost instantaneous transfer procedure, implemented on a hardware basis;
  • Legislative regulation confirming the legality of accepting such money for payment.

And yet, the value of gold in the modern world should not be underestimated. If all the leading fiat currencies – for example, the dollar or the euro – were accepted universally and without the slightest reservations, then there would be no need to accumulate reserves of gold and other precious metals.