Fiat money is a currency or can be called a medium of exchange that has been established as money, often by government regulation.
Fiat money doesn’t have intrinsic value and doesn’t have use value. It has the value for which only a government maintains its value or parties are engaging in exchange agree on its value.
It was introduced as an alternative for commodity money. A medium with its intrinsic value and representative money. Mainly money representing something with intrinsic value.
Representative money can be similar to fiat money, but it represents a claim on a commodity (which can be redeemed to a greater or lesser extent).
During the 11th century in China, government-issued fiat money banknotes were first used. Fiat money has started predomination during the 20th century.
Since President Nixon decided to decouple the U.S. dollar from gold in 1971, national fiat currencies have been used worldwide.
Any money which a government declares has to be legal tender.
State-issued money is neither convertible through a central bank to anything else. Nor fixed in value in terms of any objective standard. Money used because of government decree.
An otherwise non-valuable object serving as a medium of exchange can also be known as fiduciary money.
In monetary economics, fiat money can be an intrinsically valueless object or record accepted widely as a means of payment. Modern theories of money have tried to explain that the value of fiat money can be greater than the value of its metal content.
It contrasts with earlier monetary theories from the Middle Ages. This were more similar to the coins-as-commodity valuation of the Arrow-Debreu model.
There can be one justification for fiat money that comes from a micro-founded model. In most economic models, agents can be intrinsically happier when they have more in fiat money.
In Lagos and Wright’s model, fiat money does not have an intrinsic worth. But agents can get more of the goods they want when they trade, assuming that fiat money can be valuable.
Fiat money’s value has been created internally by the community and, at equilibrium. This makes otherwise infeasible trades possible.
Another mathematical model that has explained the value of fiat money comes from the Game of Theory. In a game where agents produced and traded objects, there can be multiple Nash equilibria where agents settled on stable behavior. In a model introduced by Kiyotaki and Wright, an object with no intrinsic worth can have value during trade in one (or more) of the Nash Equilibria.
China has a long history in the matter of paper money, beginning in the 7th century. During the 11th century, the government has established a monopoly on its issuance. Also convertibility was suspended about the end of the 12th century.
The usage of such money can become widespread during the subsequent Yuan and Ming dynasties.
Song Dynasty Jiaozi was the world’s earliest paper money.
In China, the Song Dynasty was the first behind issuing paper money, jiaozi, about the 10th century A.D. Although the notes have been valued at a certain exchange rate for gold, silver, or silk and conversion was never allowed in practice.
Initially, the notes were redeemed after three years of service, replaced by new notes for a 3% service charge. But inflation became evident as more were printed without notes being retired.
The government has been made a several attempts to maintain the value of the paper money. Just by demanding taxes partly in currency and making other laws. Still, the damage had been done, and the notes became disfavored.
During the 13th century, Marco Polo has described the fiat money of the Yuan Dynasty in his book “The Travels of Marco Polo.”
All these pieces of paper were been issued with as much solemnity and authority. As if they were made of pure gold or silver, and indeed everybody takes them readily.
For a person who may go throughout the Great Kaan’s dominions. He shall find these pieces of paper currency and shall be able to transact all sales and purchases of goods. This is by utilizing them just as well as if they were coins of pure gold.
Washington Irving records an emergency usage of paper money for sieging during the Conquest of Granada from 1482 till 1492.
In 1661, Johan Palmstruch is issued with the first regular paper money in the West by order of royal charter from the Kingdom of Sweden. Through a new institution of the Bank of Stockholm.
While this private paper currency was a failure, the Swedish parliament. This eventually assumed control of paper money.
By 1745, its paper money has been inconvertible for species, but the government-mandated acceptance.
This fiat currency can be depreciated rapidly that by 1776 it was returned to a silver standard. Fiat money also had other beginnings in 17th-century Europe, introduced by the Bank of Amsterdam in 1683.
In 17th century New France which is now a part of Canada, the universally accepted medium of exchange can be the beaver pelt.
As the colony has been expanded, coins from France have come to be widely used, but there was usually can be a shortage of French coins. In 1685, in New France, the colonial authorities can find themselves seriously short of money.
A military expedition that has gone bad against the Iroquois and tax revenues can be down. This would reduce government money reserves.
Typically, when there is a shortage of funds, the government would delay paying merchants for purchases. But it was not safe to delay payment to soldiers due to the risk of mutiny.
Before time, Fiat currency in the American Colonies was “bills of credit.” Provincial governments have produced notes which were fiat currency. With the promise of allowing holders to pay taxes with those notes.
The notes were issued for paying current obligations, and they could be used for taxes levied later. Since the notes have been denominated in the local unit of account, they have been circulated from person to person in non-tax transactions.
Particularly, these types of notes were issued in Pennsylvania, Virginia, and Massachusetts. Such money has been sold at a discount of silver by which the government would then spend and expire at a fixed date later. Some controversy from their inception has generated bills of credit.
Those who have been wanted to mainly emphasize the dangers of inflation have emphasized. The colonies where the bills of credit have been depreciated. most dramatically: New England and the Carolinas. Those who have wanted to mainly defend the use of bills of credit in the colonies have been emphasized. The middle colonies, where inflation was practically nonexistent.
Generally, after World War I, governments and banks still promised to convert notes. Also a coins into their nominal commodity (redemption by species, typically gold) on demand.
However, the fetch of the war and the repairs required and economic growth can be based on government borrowing. Afterward made governments suspend redemption by species.
Some governments were also careful for avoiding sovereign default but not possibly. This wary of the consequences of paying debts. Just By consigning newly printed cash which was not associated with a metal standard. To their creditors, which has resulted in hyperinflation.
For e.g., the hyperinflation in the Weimar Republic.
From 1944 till 1971, the Bretton Woods agreement has fixed 35 USD to one troy ounce of gold. Other currencies have been calibrated with the U.S. dollar at fixed rates. The U.S. has promised to redeem dollars with those gold that have been transferred to other national banks. Trade imbalances have been corrected by gold reserve exchanges or loans from the International Monetary Fund (IMF).
During the 1960s, production of silver coins for circulating have been ceased when the coin’s face value. This was lesser than the cost of the precious metal they have contained (whereas it has been greater historically).
In the U.S., the Coinage Act of 1965 have eliminated silver from circulating dimes and quarter dollars. Most of the other countries did the same with their coins.
The Canadian penny, mostly copper until 1996, was removed from circulation altogether. During the autumn of 2012 due to the cost of production, which was relative to face value.
In 2007, the Royal Canadian Mint had produced a million-dollar gold bullion coin and had sold five of them. In 2015, the gold present in the coins was priced more than 3.5 times the face value.
Money creation and regulation
A central bank has introduced new money into an economy by purchasing financial assets. Or lending money to various financial institutions.
Then Commercial banks can redeploy or repurpose. This base money by creating credit through fractional reserve banking. Which has expanded the total supply of “broad money” (cash plus demand deposits). In modern economies, it can be relative to the little of the supply of broad money in physical currency, for example, in December 2010 in the U.S., of the 8,853 USD.
Four billion of broad money supply around which only 915.7 billion USD means about 10% which are consisted of physical coins and paper money. The production of new physical money can usually be the responsibility of the national bank, or sometimes it is the government’s treasury.
The International Settlements banks have published a detailed review of the payment system. That is in developments in the Group of Ten (G10) countries in 1985, in the first series known as “red books.” The red books have covered the participating countries on CPMI (Committee on Payments and Market Infrastructures).
A red book has summarized the value of banknotes and coins. In circulation in which the local currency has converted into U.S. dollars using the end of the year rates.
The value of this physical currency can be as a percentage of GDP ranges from a maximum of 19.4% in Japan to a minimum of 1.7% in Sweden, with the overall average for all countries in the table being 8.9% (7.9% for the U.S.).
In many countries, the fiat currency was adopted from the 18th century, making much larger variations in the supply of money possible.
Since then, there has been mainly a huge increase in the supply of paper money which has been occurred in several countries, producing hyperinflations. Episodes for extreme inflation rates, which can be much greater than those who have observed during the earlier periods of commodity money.
In the Weimar Republic of Germany, hyperinflation can be a notable example.
Economists generally believe that high inflation rates and hyperinflation are caused by excessive growth of the money supply. Presently, most economists favor a low and steady rate of inflation.
Small as it can be opposed to zero or negative inflation, which have reduced the severity of economic recessions. Which enables the labor market for adjusting more quickly. To a recession and reduces the risk that a liquidity trap is a reluctance to lend money due to low rates of interest which prevent monetary policy from stabilizing the economy.
However, money supply growth always does not cause nominal increases in price. Instead, money supply growth may result in stable prices when they would otherwise be decreasing.
Some economists can maintain that with the conditions of a liquidity trap, large monetary injections are like “pushing on a string.”
The duty of keeping the inflation rate can be small and stable if it is usually given to monetary authorities.
Generally, these monetary jurisdictions are the national banks controlling monetary policy. By setting interest rates, open market operations, and setting banking reserve requirements.
Loss of backing
A fiat-money currency can greatly lose its value that should be the issuing of government or central bank. Which either loses the ability to or refuses to continue to guarantee its value.
The usual consequence is hyperinflation. Some examples of this are China’s money during 1945, the Zimbabwean dollar, and the Weimar Republic’s mark during 1923.
A more recent example is the currency instability in Venezuela that began in 2016 during the country’s ongoing socio-economic and political crisis.
But this need not necessarily occur, especially if a currency continues to be the most easily available. For example, the pre-1990 Iraqi dinar continued to retain value in the Kurdistan Regional Government. Even after the Iraqi legal tender status was ended government, which issued the notes.
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