Fiat Money or Fiat Currency is any money that the government declares as legal tender. Also, this type of money is not backed by a physical commodity such as gold or silver. In other words, fiat money has no intrinsic value. Market forces determine the value of fiat money.
In economics, the term ‘market forces’ refers to the forces of supply and demand. When demand rises faster than supply, the price of something tends to go up. When demand declines, on the other hand, prices tend to fall.
The transition to fiat currency has enabled governments to exercise greater control over their economies, allowing for adjustments in money supply to meet the financial challenges of different historical periods.
Alternative to representative/commodity money
Governments introduced this type of money as an alternative to representative and commodity money. Commodity money is, for example, a valuable metal such as gold that we use as currency. A gold coin is an example of commodity money. Representative money represents a claim on a commodity.
We sometimes refer to commodity or representative money as ‘backed currency.’
All national currencies today that are in circulation, and that central banks issue and manage, are fiat currencies.
Wikipedia has the following four definitions of fiat money:
“1. Any money declared by a government to be legal tender. 2. State-issued money which is neither convertible by law to any other thing, nor fixed in value in terms of any objective standard.”
“3. Intrinsically valueless money used as money because of government decree. 4. An intrinsically useless object that serves as a medium of exchange, i.e., fiduciary money.”
Regarding fiat money, the Bank of England says: “One advantage of a system that uses fiat money is that the amount of money in circulation can be responsive to changing economic conditions. This can support the smooth functioning of the economy.”
Etymology of fiat money
Etymology is the study of where words came from, i.e., their origins, and how their meanings have evolved.
Etymonline.com says that the word ‘fiat’ emerged in the English language in the 1630s. It meant ‘authoritative sanction.’
It comes from the Latin word Fiat meaning ‘let it be done.’ It is the passive of the Latin word Facere, meaning ‘to make, do.’
In 1750, the English word ‘fiat’ began also to mean ‘a decree, order, command.’
According to Dictionary.com, it was not until 1870-1875 that we started using the term ‘fiat money’ with its modern meaning.
Fiat money – brief history
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China
Fiat money dates back to 11th-century China. Its use was widespread during the Ming and Yuan dynasties.
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Europe
Around 1100 AD, Henry I, King of England, initiated the use of tally sticks due to a gold shortage.
In Spain, during the conquest of Granada (1482-1492), the authorities issued paper money as an emergency measure.
The Bank of Stockholm in Sweden issued the first regular paper money in the West in 1661. However, by 1776, the fiat money had devalued so badly that Sweden returned to the silver standard.
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The Americas
New France, today part of Canada, began issuing paper money in 1685.
During the 18th and 19th centuries, ‘bills of credit’ became widespread in the American Colonies. Bills of credit were an early form of fiat currency.
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20th century
After the First World War, many countries gradually converted to fiat money.
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United Kingdom
The United Kingdom abandoned the gold standard in 1931, i.e., on that date, the pound sterling became a fiat currency.
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United States
However, the United States still pegged its currency to gold for several years. It was not until 1971 that the US turned the dollar into a complete fiat currency.
Modern economies rely on the flexibility of fiat currencies to implement monetary policies that stabilize markets and address inflation or deflation.
Video – What is fiat money?
This video, from our sister channel on YouTube – Marketing Business Network, explains what ‘Fiat Money’ is using simple and easy-to-understand language and examples.