A country’s central bank issues fiat currency and controls its supply. The bank can also influence the demand for the currency by changing interest rates and manipulating the money supply. Because fiat currencies aren’t backed by anything tangible, their value can fluctuate wildly, which can lead to inflation or deflation.
The History of Fiat Currency
Fiat currencies have been around for centuries, but they really came into their own in the 20th century. Before 1971, most major world currencies were pegged to the price of gold, which helped to stabilize their value. However, this system eventually broke down, and countries began to issue their own fiat currencies.
The United States Dollar was one of the first major fiat currencies, and it remains one of the most widely-used fiat currencies today. Other examples of fiat currencies include the Euro, the Japanese Yen, and the Chinese Yuan.
Pros and Cons of Fiat Currency
There are both pros and cons to using a fiat currency. On the plus side, fiat money is more convenient than commodity-backed money because it doesn’t have to be physically transported every time it changes hands. Fiat money is also more versatile than other types of money—it can be used for everything from buying groceries to paying taxes.
On the downside, fiat money is subject to inflationary pressures because Central Banks can print as much of it as they want. This can lead to higher prices and lower purchasing power over time. Additionally, fiat currencies are not backed by anything of value, so their value can fluctuate sharply if confidence in a country’s economy begins to wane.
Why do modern economies prefer Fiat money?
Most nations used gold standards or commodities back in the 20th century. As international trade and finance became more expansive and diversified however, the limited amounts from mining to central banks could not cope with the new wealth resulting, causing significant disruption to global markets. This allows the governments the freedom to manage their own currencies and to make policies on their monetary system. It allows fractional reserves, which allow financial institutions to multiply money in hand and satisfy demand from borrowers.
Example of Fiat Money Gone Wrong: Hyperinflation
Zimbabwe was an example of one of the worst cases in the late 1990s. When the central banks faced severe economic challenges they began printing money at unprecedented rates, leading to hyperinflation. Experts believe it will lose 97.8% from its original value over the period. The price went up rapidly and customers had to take money to buy basic necessities in bags. During a severe economic crisis, Zimbabwe has opted for an issuance of a ten-million US dollar currency note. Eventually, foreign currency was increasingly accepted in the market.
Is Fiat money worth it?
The fiat money is supported by the government that has issued them. It’s worth considering if governments require you to pay taxes on your fiat money. Since all people must pay taxes or risk hefty punishments or imprisonment, people will accept it as an alternative. The theory that money can only exist in a credit-debt relationship suggests another theory that money is irrelevant to making money worthless.
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The Future of Fiat Currency
In virtually all countries now fiat currency is legally available, and it’s impossib
le to predict how this will be. Despite growing popularity of cryptocurrencies, some experts believe it will eventually replace fiat currencies altogether.
Fiat currency is government-issued money that isn’t backed by a physical commodity. This type of currency has value because the government says it does—hence the name “fiat,” which comes from the Latin word for “let it be done.” Fiat currencies have been around for centuries but they really came into their own in 20th century when countries began issuing their own unpegged currencies. There are both pros and cons to using a fiat currency—it is more convenient than other types of money but it is also subject to inflationary pressures because Central Banks can print as much of it as they want.