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What is Fiat Money ?

fiat-money

The reason that fiat currency is such an important term and gets used so much is because it is referring to the currency that most of us use every day.

Fiat money is the term used to refer to the currency made up of coins and banknotes that are valid and in circulation in a given country. Its value is based on the confidence of its users and not on the cost of making it.

For example, a 20 dollar bill is worth 20 dollars, not by the cost of its manufacture, but by the fact that its users see it as a 20 dollar bill allowing them to acquire a product or service of the same value. Contrary to what one might be tempted to believe, fiat money represents “only” 15% of the money supply. To find out even more, here is our comprehensive guide to currency in circulation.

Its Value :

The value of a fiduciary currency is not linked to the price of a precious metal. It, therefore, has no intrinsic value. Its price is based on the credit given to it by economic agents and the international financial community. It is exchangeable in goods for its nominal value.

In the USA, the Federal bank is the guarantor of the dollar.

The uses linked to the development of e-commerce and the development of contactless payment are gradually reducing the need to hold cash, which’s becoming superfluous.

The money supply and its measurement

Money supply: The amount of money in circulation within a specified area; in circulation, that is, held by agents that do not credit institutions.

The money supply is measured by listing the assets that are considered monetary assets.

Monetary assets are defined in terms of their liquidity.

On the basis of this functional criterion, three monetary aggregates are defined:
M1, M2, M3.

M 1 = fiat money (banknotes and coins) + scriptural money (money in the form of deposits and movable by cheques)

Fiat money is called “central bank money” because only the central bank is authorized to issue it. It represents about 15% of M1 and despite its small share, it is the central bank money that provides security. Because the other forms of money are linked to it by a convertibility obligation.

A bank must hold them for three operations :

  • over-the-counter withdrawals
  • The other banks are not interested in scriptural money because they only accept central bank money, since it’s free of charge.
  • reserve requirements at the central bank (each bank is required to have a current account at the central bank and to hold 5% of residents’ deposits and 3% of non-residents’ deposits there).

M 2 = M1 + savings accounts
M 3 = M2 + securities issued by financial institutions

M 3 is used as a reference when talking about the money supply.

Its Advantages :

The use of cash for everyday purchases and small amounts remains practical even though contactless payment by credit card is developing rapidly.

Another positive point is that fiat money allows you to calibrate your spending according to what you have in your pocket. Also, bills and coins are accepted everywhere and immediately free up payment.

Also :

Scarcity: Currency is not affected or limited by the scarcity of a physical commodity such as gold.
Cost: The production of paper money is cheaper than a commodity-based currency.
Responsiveness: fiat money gives governments and their central banks the flexibility to deal with economic crises.
International trade: fiat money is used worldwide, making it a form of currency suitable for international trade.
Convenience: Currency is not tied to physical gold reserves that require costly physical storage, protection, monitoring and other requirements.

Its Disadvantage :

The main disadvantage of fiat money is that it has only a convenience value. If inflation rises, its value falls.

With the advent of the cashless society through e-money, we find ourselves with 90% of legal tender in the form of book entries.

Also :

No intrinsic value: Currency has no intrinsic value. This allows governments to create money from scratch (banknote printing plate), which can lead to hyperinflation and the collapse of the economic system.
Historically risky: Historically, the implementation of fiat money systems has generally led to financial crises, which implies certain risks.

Could It Lose Its Value ?

The value of coins and banknotes does not change over time or with changes in ownership. On the other hand, the purchasing power linked to the holding of these coins and bills evolves over time. Indeed, fiat money is subject to the effects of inflation. The higher the rate of inflation, the more the purchasing power associated with holding these coins and bills is eroded.

A country’s currency can also devalue in the financial markets via the exchange rate. In this case, the currency loses value against another currency. To compare the evolution of purchasing power between 2 currencies, the purchasing power parity is used.

How this banking money is created ?

The amount shown on your bank statement is indeed legal tender guaranteed by a central bank. Against these “figures” you will get goods and services that correspond to the expected amount. These sets of entries are referred to as scriptural money, which happens to be a form of fiat money.

Unless you no longer have trust in the banking system, which substitutes itself for a state to guarantee that you will have access to your money.

This is why, since the subprime crisis of 2008, those of Argentina or Cyprus, financial institutions have multiplied laws and regulations that “guarantee individuals up to 100,000 dollars “registered” in their bank account even in the event of a bank failure. In reality, the Cyprus crisis showed that a state could decree on a Friday evening that no more bills or coins would leave a bank until at least the following Monday.

The Value of E-Money :

In fact, beyond the sums indicated on accounts, we have more and more often in our pockets money that is not in the form of bills or coins. Payment cards are multiplying.

Their intrinsic value: the price of a plastic rectangle, a chip (sometimes), and a lot of computer technology. Nothing to do with the “no limit” spending of a high-end bank card, the latter having nothing to do with the membership card of your favorite supermarket which entitles you to discounts of a few dollars.

All money is more or less fiduciary :

Even gold in its time was subordinated to the credit given to it. It was customary that if the monetary authorities gave a gold coin a price that was disconnected from the price of the incorporated metal.Then it was accused of being fiat money. Even more so, the share demanded of confidence increases if the gold content is reduced if the base metal is substituted for the precious metal if the currency is made of worthless material.

And conversely, for legal tender gold coins, the intrinsic value is generally higher than the face value. That is to say, a $50 Maple Leaf gold coin, which is of great purity, is worth much more if we limit ourselves to its weight in gold!

First Fiat Money In China

In this game, the United States and its dollar are obviously not innovative. In fact, the first fiduciary coins “worthy” of the name were created in China as early as 140 BC when Emperor Wou-Ti issued coins made of a silver-tin alloy. He assigned them an arbitrary price: 300 copper tokens for the oval coin, 500 for the square coin, and 3000 for the round coin. He also creates squares of white suede and silk with the official seal, with a course of 40,000 copper coins. At the time, these issues did not cost the Treasury anything and gave it singular facilities.

In fact, China abused them on several occasions, especially from the day it knew how to make paper. In the first century A.D., the Chinese obtained thin sheets of pulp, first from a slurry of silk waste, then from the fibers of mulberry trees and bamboo. They have also long possessed the secret of indelible inks based on smoke black. They will soon be able to mold ideograms in clay to form mobile characters. Paper, ink, and printing: this is what was to dethrone gold for several centuries. At the same time, the Chinese had just invented paper money and its corollary, inflation… But this is another story that we will tell you later.

Currency And Crisis Of Trust

Historically, the dollar is finally still young. But confidence is not eternal. Why would it be any different with a currency that is precisely based on trust?

Alternatives ?

The crisis of trust that Fiat Money is undergoing today is pushing citizens to turn to new monetary models, including crypto money, local currencies, and open-source currencies.

Conclusion :

The future of these two forms of currency is by no means assured. While crypto-currencies still have a long way to go and will certainly face many challenges, the history of fiat money demonstrates the vulnerability of this type of currency. This is an important reason why many people are exploring the possibility of switching to a crypto-currency system to secure their financial transactions – at least to some extent.

One of the main ideas behind the creation of Bitcoin and crypto-currencies is to explore a new form of currency based on a distributed peer-to-peer network. Chances are that Bitcoin was not created to replace the entire system of fiat money, but to provide an alternative economic network that could create an improved financial system for a better society.

Written by Ottay

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