Fiat money
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Fiat money is a type of currency that is not backed by a precious metal, such as gold or silver. It is typically designated by the issuing government to be legal tender, and is authorized by government regulation. Since the end of the Bretton Woods system in 1971, the major currencies in the world are fiat money.
Fiat money generally does not have intrinsic value and does not have use value. It has value only because the individuals who use it as a unit of account – or, in the case of currency, a medium of exchange – agree on its value.[1] They trust that it will be accepted by merchants and other people as a means of payment for liabilities.
Fiat money is an alternative to commodity money, which is a currency that has intrinsic value because it contains, for example, a precious metal such as gold or silver which is embedded in the coin. Fiat also differs from representative money, which is money that has intrinsic value because it is backed by and can be converted into a precious metal or another commodity. Fiat money can look similar to representative money (such as paper bills), but the former has no backing, while the latter represents a claim on a commodity (which can be redeemed to a greater or lesser extent).[2][3][a]
Government-issued fiat money banknotes were used first during the 13th century in China.[4] Fiat money started to predominate during the 20th century. Since President Richard Nixon's decision to suspend US dollar convertibility to gold in 1971, a system of national fiat currencies has been used globally.
Fiat money can be:
- Any money that is not backed by a commodity.
- Money declared by a person, institution or government to be legal tender,[5] meaning that it must be accepted in payment of a debt in specific circumstances.[6]
- State-issued money which is neither convertible through a central bank to anything else nor fixed in value in terms of any objective standard.[7]
- Money used because of government decree.[2]
- An otherwise non-valuable object that serves as a medium of exchange[8] (also known as fiduciary money).[9]
The term fiat derives from the Latin word fiat, meaning "let it be done"[b] used in the sense of an order, decree[2] or resolution.
Treatment in economics
Most of the money in the economy is created, not by printing presses at the central bank, but by banks when they provide loans. [...] This also means as you pay off the loan, the electronic money your bank created is 'deleted' – it no longer exists. So essentially, banks create money, not wealth.[10]
In monetary economics, fiat money is an intrinsically valueless object or record that is accepted widely as a means of payment.[1] Accordingly, the value of fiat money is greater than the value of its metal or paper content.
One justification for fiat money comes from a micro-founded model. In most economic models, agents are
In the Grundrisse, Karl Marx was among the first to consider the modern economic ramifications of a historical switch to fiat money from the gold or silver-commodity. Marx writes:
"Suppose that the Bank of France did not rest on a metallic base, and that other countries were willing to accept the French currency or its capital in any form, not only in the specific form of the precious metals. Would the bank not have been equally forced to raise the terms of its discounting precisely at the moment when its "public" clamoured most eagerly for its services? The notes with which it discounts the bills of exchange of this public are at present nothing more than drafts on gold and silver. In our hypothetical case, they would be drafts on the nation's stock of products and on its directly employable labour force: the former is limited, the latter can be increased only within very positive limits, and in certain amounts of time. The printing press, on the other hand, is inexhaustible and works like a stroke of magic."
Commenting on the passage, economist and geographer David Harvey writes that "[t]he consequence, as Marx saw it, would be that "the directly exchangeable wealth of the nation" would be ‘absolutely diminished’ alongside of ‘an unlimited increase of bank drafts’ (i.e., accelerating indebtedness) with the direct consequence of ‘increase in the price of products, raw materials and labour’ (inflation) alongside a ‘decrease in price of bank drafts’ (ever-falling rates of interest)." Harvey notes the accuracy of the modern economy in this way, save for "...the rising prices of labor and means of production (low inflation except for assets such as stocks and shares, land and property and resources such as water rights)."[12] The latter point can be explained by the private exportation of debt,[13] labour, and figurative and/or literal waste[14] to the global periphery, a concept related to metabolic and carbon rift.
Another mathematical model that explains the value of fiat money comes from game theory. In a game where agents produce and trade objects, there can be multiple Nash equilibria where agents settle on stable behavior. In a model by Kiyotaki and Wright, an object with no intrinsic worth can have value during trade in one (or more) of the Nash Equilibria.[15]
History
China
China has a long
The
The succeeding
During the 13th century,
All these pieces of paper are issued with as much solemnity and authority as if they were of pure gold or silver... and indeed everybody takes them readily, for wheresoever a person may go throughout the Great Kaan's dominions he shall find these pieces of paper current, and shall be able to transact all sales and purchases of goods by means of them just as well as if they were coins of pure gold.
— Marco Polo, The Travels of Marco Polo
Europe
New France 1685–1770
In 17th century New France, now part of Canada, the universally accepted medium of exchange was the beaver pelt. As the colony expanded, coins from France came to be used widely, but there was usually a shortage of French coins. In 1685, the colonial authorities in New France found themselves seriously short of money. A military expedition against the Iroquois had gone badly and tax revenues were down, reducing government money reserves. Typically, when short of funds, the government would simply delay paying merchants for purchases, but it was not safe to delay payment to soldiers due to the risk of mutiny.
Jacques de Meulles, the Intendant of Finance, conceived an ingenious ad hoc solution – the temporary issuance of paper money to pay the soldiers, in the form of playing cards. He confiscated all the playing cards in the colony, had them cut into pieces, wrote denominations on the pieces, signed them, and issued them to the soldiers as pay in lieu of gold and silver. Because of the chronic shortages of money of all types in the colonies, these cards were accepted readily by merchants and the public and circulated freely at face value. It was intended to be purely a temporary expedient, and it was not until years later that its role as a medium of exchange was recognized. The first issue of playing card money occurred during June 1685 and was redeemed three months later. However, the shortages of coinage reoccurred and more issues of card money were made during subsequent years. Because of their wide acceptance as money and the general shortage of money in the colony, many of the playing cards were not redeemed but continued to circulate, acting as a useful substitute for scarce gold and silver coins from France. Eventually, the Governor of New France acknowledged their useful role as a circulating medium of exchange.[23]
As the finances of the French government deteriorated because of European wars, it reduced its financial assistance to its colonies, so the colonial authorities in Canada relied more and more on card money. By 1757, the government had discontinued all payments in coin and payments were made in paper instead. In an application of
The Royal Canadian Mint still issues Playing Card Money in commemoration of its history, but now in 92.5% silver form with gold plate on the edge. It therefore has an intrinsic value which considerably exceeds its fiat value.[24] The Bank of Canada and Canadian economists often use this early form of paper currency to illustrate the true nature of money for Canadians.[23]
18th and 19th century
Country | Year |
---|---|
United Kingdom | 1821 |
Germany | 1871 |
Sweden | 1873 |
United States (de facto) | 1873 |
France | 1874 |
Belgium | 1874 |
Italy | 1874 |
Switzerland | 1874 |
Netherlands | 1875 |
Austria-Hungary | 1892 |
Japan | 1897 |
Russia | 1898 |
United States (de jure) | 1900 |
An early form of fiat currency in the
Bills of credit have generated some controversy from their inception. Those who have wanted to emphasize the dangers of inflation have emphasized the colonies where the bills of credit depreciated most dramatically: New England and the Carolinas.[26] Those who have wanted to defend the use of bills of credit in the colonies have emphasized the middle colonies, where inflation was practically nonexistent.[26]
Colonial powers consciously introduced fiat currencies backed by taxes (e.g.,
Examples include the "
During the
20th century
After World War I, governments and banks generally still promised to convert notes and coins into their nominal commodity (redemption by specie, typically gold) on demand. However, the costs of the war and the required repairs and economic growth based on government borrowing afterward made governments suspend redemption by specie. Some governments were careful of avoiding sovereign default but not wary of the consequences of paying debts by consigning newly printed cash not associated with a metal standard to their creditors, which resulted in hyperinflation – for example the hyperinflation in the Weimar Republic.
From 1944 to 1971, the
The Bretton Woods system was ended by what became known as the Nixon shock, a series of economic changes by United States President Richard Nixon in 1971. These changes included unilaterally canceling the direct convertibility of the United States dollar to gold. Since then, a system of national fiat monies has been used globally, with variable exchange rates between the major currencies.[29]
Precious metal coinage
During the 1960s, production of silver coins for circulation ceased when the face value of the coin was less than the cost of the precious metal it contained (whereas it had been greater historically). In the United States, the Coinage Act of 1965 eliminated silver from circulating dimes and quarter dollars, and most other countries did the same with their coins.[30] The Canadian penny, which was mostly copper until 1996, was removed from circulation altogether during the autumn of 2012 due to the cost of production relative to face value.[31]
In 2007, the Royal Canadian Mint produced a million dollar gold bullion coin and sold five of them. In 2015, the gold in the coins was worth more than 3.5 times the face value.[32]
Money creation and regulation
A
In modern economies, relatively little of the supply of broad money is physical currency. For example, in December 2010 in the U.S., of the $8,853.4 billion of broad money supply (M2), only $915.7 billion (about 10%) consisted of physical coins and paper money.[34] The manufacturing of new physical money is usually the responsibility of the national bank, or sometimes, the government's treasury.
The
Country | Billions of dollars | Per capita |
---|---|---|
United States | $1,425 | $4,433 |
Eurozone | $1,210 | $3,571 |
Japan | $857 | $6,739 |
India | $251 | $195 |
Russia | $117 | $799 |
United Kingdom | $103 | $1,583 |
Switzerland | $76 | $9,213 |
Korea | $74 | $1,460 |
Mexico | $72 | $599 |
Canada | $59 | $1,641 |
Brazil | $58 | $282 |
Australia | $55 | $2,320 |
Saudi Arabia | $53 | $1,708 |
Hong Kong SAR | $48 | $6,550 |
Turkey | $36 | $458 |
Singapore | $27 | $4,911 |
Sweden | $9 | $872 |
South Africa | $6 | $113 |
Total/Average | $4,536 | $1,558 |
The most notable currency not included in this table is the Chinese yuan, for which the statistics are listed as "not available".
Inflation
The adoption of fiat currency by many countries, from the 18th century onwards, made much larger variations in the supply of money possible. Since then, huge increases in the supply of
The task of keeping the rate of inflation small and stable is usually given to
Loss of backing
A fiat-money currency greatly loses its value should the issuing government or central bank either lose the ability to, or refuse to, continue to guarantee its value. The usual consequence is hyperinflation. Some examples of this are the Zimbabwean dollar, China's money during 1945 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 socioeconomic and political crisis.
This need not necessarily occur, especially if a currency continues to be the most easily available; for example, the pre-1990
See also
- Criticism of the Federal Reserve
- Cryptocurrency
- Debasement
- Debt based monetary system - monetary system where commercial banks create the new money as debt
- Fractional-reserve banking
- Hard currency
- Inflation hedge
- Modern monetary theory
- Money creation
- Money supply
- Network effect
- Seigniorage
- Silver coin
- Silver standard
Notes
- ^ See Monetary economics for further discussion.
- ^ Fīat is the third-person singular present active subjunctive of fiō ("I become", "I am made").
References
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Fiat Money. Money which a government declares shall be accepted as legal tender at its face value;
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- ^ John Maynard Keynes (1965) [1930]. "1. The Classification of Money". A Treatise on Money. Vol. 1. Macmillan & Co Ltd. p. 7.
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