When was fiat money created

Fiat money is a government-issued currency that is not backed by a physical commodity, such as gold or silver, but rather by the government that issued it. The value of fiat money is derived from the relationship between supply and demand and the stability of the issuing government, rather than the worth of a commodity backing it. Most modern paper currencies are fiat currencies, including the U.

The term "fiat" is a Latin word that is often translated as "it shall be" or "let it be done. Fiat currency came about when governments would mint coins out of a valuable physical commodity, such as gold or silver, or print paper money that could be redeemed for a set amount of a physical commodity. Fiat, however, is inconvertible and cannot be redeemed simply because there is no underlying commodity backing it.

Because fiat money is not linked to physical reserves, such as a national stockpile of gold or silver, it risks losing value due to inflation or even becoming worthless in the event of hyperinflation. In some of the worst cases of hyperinflation , such as in Hungary immediately after WWII, the rate of inflation can double in a single day.

Furthermore, if people lose faith in a nation's currency, the money will no longer hold value. This is much different from a currency backed by gold, for example; it has intrinsic value because of the demand for gold in jewelry and decoration as well as the manufacture of electronic devices, computers, and aerospace vehicles. The U. Legal tender is basically any currency that a government declares to be legal. Many governments issue a fiat currency, then make it legal tender by setting it as the standard for debt repayment.

Earlier in U. The federal government stopped allowing citizens to exchange currency for government gold with the passage of the Emergency Banking Act of The gold standard , which backed U. Since that time, U. In this sense, U. Fiat money serves as a good currency if it can handle the roles that a nation's economy needs of its monetary unit—storing value, providing a numerical account, and facilitating exchange.

It also has excellent seigniorage , meaning it is more cost-efficient to produce than a currency directly tied to a commodity. Fiat currencies gained prominence in the 20th century in part because governments and central banks sought to insulate their economies from the worst effects of the natural booms and busts of the business cycle.

Since fiat money is not a scarce or fixed resource like gold, central banks have much greater control over its supply, which gives them the power to manage economic variables such as credit supply, liquidity, interest rates, and money velocity.

For instance, the U. Federal Reserve has the dual mandate to keep unemployment and inflation low. The mortgage crisis of and subsequent financial meltdown, however, tempered the belief that central banks could necessarily prevent depressions or serious recessions by regulating the money supply.

A currency tied to gold, for example, is generally more stable than fiat money because of the limited supply of gold. There are more opportunities for the creation of bubbles with fiat money due to its unlimited supply. The African nation of Zimbabwe provided an example of the worst-case scenario in the early s.

In response to serious economic problems, the country's central bank began to print money at a staggering pace, resulting in hyperinflation. Experts suggest the currency lost Prices rose rapidly and consumers were forced to carry bags of money just to purchase basic staples. At the height of the crisis, the Zimbabwe government was forced to issue a trillion Zimbabwean dollar note. Eventually, foreign currencies were used more widely than the Zimbabwean dollar. In contrast to commodity-based money like gold coins or paper bills redeemable for precious metals, fiat money is backed entirely by the full faith and trust in the government that issued it.

One reason this has merit is because governments demand that you pay taxes in the fiat money it issues. Since everybody needs to pay taxes, or else face stiff penalties or prison, people will accept it in exchange this is known as Chartalism.

Other theories of money, such as the credit theory, suggest that since all money is a credit-debt relation, it does not matter if money is backed by anything to maintain value. Prior to the 20th century, most countries utilized some sort of gold standard or backing by a commodity. As international trade and finance grew in scale and scope, however, the limited amount of gold coming out of mines and in central bank vaults could not keep up with the new value that was being created, causing serious disruptions to global markets and commerce.

Hyperinflation—extremely fast and out-of-control inflation—caused the currency to lose its value. The government began printing banknotes with higher values in order to keep up with inflation. The country's central bank had to stop printing money, causing the Zimbabwe dollar to officially lose value in the foreign currency market.

The country eventually turned to the U. Representative money is government-produced money backed by a physical commodity such as precious metals. Other forms of representative money are still in place, including financial instruments like checks and credit cards. These forms of payment are used today in place of traditional money, with the intent to pay at a later date. Representative money has a long history.

In the 17th and early 18th centuries, furs and commodities like corn were used in transactions. This was followed by precious metals like gold and silver. Up until , the world followed the gold standard, where a person was able to exchange the money they held directly for gold. A country that followed the gold standard set a fixed price for gold, buying and selling gold at that price. That fixed price was used to determine the value of the currency. The major appeal for representative money was that it was not influenced by inflation—governments were only able to print enough money for the amount of gold they held in their vaults.

While fiat money doesn't have intrinsic value —that being through an objective calculation—its value is set by the government that issues the currency. Most modern currencies around the world are forms of fiat money. Fiat money can be used to buy goods and services since both parties involved in a transaction agree on the currency's value. Representative money, on the other hand, is valued based on the instrument backing it, whether that's a commodity, asset , or another financial instrument such as a check.

A single dollar may, for instance, be worth a specific amount of gold. Most currencies are no longer backed by commodities.

But there are still other forms of representative money, such as checks, money orders , and bank drafts. They can be exchanged for the value listed on the instrument. As mentioned above, the United States severed its ties with the gold standard in , turning its currency into fiat money. That led all national currencies to be valued against the U. Instead of using gold as the power behind the money, the government is the strength and the reason fiat money has value.

The money has value because the government says it does. In turn, people want to have fiat money. If the government falls on hard times or if people everywhere suddenly did not want a form of currency such as the U. But many governments end up printing too much paper money, which leads to inflation. A dollar is no longer worth a dollar in gold. When this happens, the money becomes fiat money. Fiat money is a form of currency that is backed by a country's government.

As such, this form of money retains its value through the stability of the government and the national economy. Yes, fiat money does have value. Its value is determined by the government, not by the material from which it is produced. The term is derived from the Latin word fiat, which means a determination by authority—in this case, it's the government that decrees the value of the currency and isn't representative of another asset or financial instrument such as gold or a check.

Bitcoins aren't backed by commodities, so they're not necessarily a form of representative currency. They are, though, backed by the faith of investors and—to some degree—governments, so they may be considered a form of fiat currency. Or, if you are already a subscriber Sign in. Other options. Close drawer menu Financial Times International Edition.

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