What Is Fiat Money?
Fiat Money Definition
Fiat money is currency issued by a government that is backed by the authority and power of that government and its economy, rather than a physical commodity.
Historically, governments would mint money out of gold and silver, metals with inherent value due to their rarity and desirability.
Fiat money, however, is not based on the value of any commodity. Its value exists because the issuing government has declared that it has value, hence the term “fiat,” from the Latin “let it be.”
Purpose of Fiat Money
The purpose of fiat money is to increase the stability of a currency and the central bank’s ability to control the money supply.
Before the US dollar had been severed from the gold standard, for example, people would historically hoard gold in times of economic uncertainty.
This caused market shocks to be exacerbated.
Gold is also an investment that typically grows more slowly and sporadically than the overall stock market; for example, since Nixon eliminated the gold standard in the 1970’s gold has seen a 460% appreciation in value, while the S&P 500 has grown by over 2,200%.
Fiat Money Pros and Cons
There are advantages and disadvantages of using fiat money as a primary currency.
It has the advantage of being able to store value easily, being easier to keep and move around than equivalent values of gold or other resources.
Because it is not based on any fixed or scarce commodities like precious metals, central banks also have much greater control over the supply of money in an economy.
However, despite normally being stable, if too much is minted fiat money has the potential to bottom out and lose all value, such as with the German mark circa 1923.