The term fiat money (from the Latin “fiat” meaning “let it be done”) or fiat money or legal tender money or even fiduciary money, indicates a payment instrument not anchored to the price of a raw material such as gold or silver, and without intrinsic value (even indirect). Fiat is a term that derives from Latin and can be translated as “let it be made”, which in this case alludes to the fact that this currency “is made”, that is, it is issued by the government.
As just said, fiat money does not have an intrinsic value like gold does, therefore its value is decreed by an authority (the State) by law, by virtue of the “lex monetae” principle. The Latin expression “Lex monetae” indicates the power of a sovereign state to choose which currency to adopt and to determine its value according to its own laws. This is a universally accepted principle of law. Therefore it is the State that guarantees the value of a legal tender currency. The trust given to the State is automatically also given to the currency it issues.
What are its main characteristics of a fiat currency?
The main characteristics of a fiat currency are as follows:
- stability is guaranteed by the control of issuance by central banks;
- recognition as a means of payment is guaranteed by law;
- the country that issues the currency accepts it – or rather, requires it – as a valid means of paying taxes;
Fiat money vs Commodity money
The concept of fiat money is therefore contrasted with the concept of commodity money. The term commodity money means a payment instrument represented by an assetAsset An economic resource with value that an individual or organization owns, controls, or expects future benefits from. Examples of assets: gold, stocks, cryptocurrencies, etc. with its own intrinsic value, i.e. independent of its use as a payment instrument. Simply put, a commodity that is used as a medium of exchange.
From commodity money to fiat money
The first forms of “money” that allowed us to move from an inefficient exchange system such as direct barter to a more advanced exchange system such as mediated barter were goods with their own intrinsic value, such as salt, spices, cereals, silk, etc, but also animals such as sheep, cows, camels, etc. and even people such as slaves.
It is interesting to note how some terms that are still used today originate from the name of the goods used as money. For example, salt was considered very precious because it was used to preserve food (in ancient times there were no refrigerators and there was a need to preserve food for long periods). Being so valuable, salt was used as currency. In fact, the term salary derives from the Latin (“salarium”, i.e. “salt ration”), as in ancient Rome soldiers were often paid a ration of salt as a supplement to their pay. Pecunia derives from the Latin “pecus”, which means sheep. The term carat derives from the Arabic “quirat” (twenty-fourth part), in turn deriving from the Greek “kerátion” i.e. carob seeds (whose seeds were believed to have an exceptionally constant mass).
Some commodity currencies such as sheep or rice involved problems of divisibility, perishability and difficulty in transportation. To overcome these problems, the use of precious metals was introduced, such as gold and silver, which can be divided, are not perishable and are easily transportable. Then ingots were born, which could be divided into pieces of uniform weight and finally metal coins. Tradition has it that the coin was minted for the first time by Croesus, king of Lydia, in the 6th century BC. In the following century the use of minting coins spread to the Persian Empire and Greek cities. Then, through the Greeks, the use of money was introduced to the Western Mediterranean. Finally, at the time of Alexander the Great, it also spread to India. Coins were a revolution: counting coins is in fact easier than weighing metals.
In ancient times, when the monetary base consisted of precious metal coins, anyone who had precious metal could take it to the state mint, where it was transformed into coins with the effigy of the sovereign. The rights belonging to the mint and the sovereign were exacted by retaining a part of the precious metal, called seigniorage. Seigniorage in this context is therefore the coinage tax, also known as mint duty.
However, minting coins with precious metals entailed problems as the shortage of gold and silver often led to difficulties in producing the coins. The sovereigns’ responses were to produce lighter coins or ones with a lower gold or silver content, because bronze and copper were mixed with the more precious metals. In other words, the same amount of precious metals produced more coins.
With the industrial revolution and, in the 20th century, with the Bretton Woods Conference, we witnessed the gradual abandonment of monetary systems based on precious metals and the convertibility of currencies into precious metals. The growth of economic exchanges caused by the industrial revolution made it necessary to use currencies whose supply was not constrained by the limited availability of precious metals. the success of the bank note and other forms of payment free from the use of precious metals is explained by the practicality of payment systems which do not require the transfer of large quantities of heavy precious metal.
Curiosity: the term dollar derives from the German thaler, the name of a silver coin minted starting from the sixteenth century by some Germanic states and, in the following centuries, always with this name, by many European princes. In turn, this word derives, by abbreviation, from JoachimsTHAL, the name of a silver mine in Bohemia from which the Schlick princes, owners, obtained silver for the minting of coins. Already in the second half of the sixteenth century in England the name had become dollar.
What are the different types of fiat currency?
According to Eurochange (a British exchange company based in Stevenage, https://www.eurochange.co.uk/travel/tips/world-currency-abbreviations-symbols-and-codes-travel-money), today there are 180 world currencies circulating in 197 countries. Examples of breath currencies are the Euro, the Dollar and the Pound: the value of one currency compared to another is called the exchange rate, the criterion underlying forex trading.
Advantages and disadvantages of fiat money
Finally, let’s see what the advantages and disadvantages of fiat money are.
Advantages:
- Convenience: Fiat money is not dependent on physical reserves of gold which would require space, protection, monitoring and other expensive requirements
- Cost: Fiat money is cheaper to produce than commodity money.
- Centralized regulation: Fiat money provides governments and central banks with the flexibility to deal with economic crises.
- International Trade: Fiat money is used in nations around the world, making it an acceptable form of currency for international trade.
Disadvantages
Lack of intrinsic value: Fiat money has no intrinsic value, which allows governments to create money out of thin air. Therefore the value of fiat money is subject to responsible fiscal policy and government regulation. However, irresponsible monetary policy could lead to inflationInflation A sustained increase in the general price level of goods and services in an economy over time. or hyperinflation of fiat money.