28 Jun Fiat Currency
[Note from the author: This post was originally published in 2012 on a blog entitled “Further to Freedom.” This blog was an attempt of mine to communicate some of the complexities of economics in an accessible, easy-to-understand way. The blog was organized by ‘Levels’, which I thought would help readers to select articles which better corresponded to their level of economic understanding. I had originally envisioned this as a collaborative project and wanted to bring in a handful of others to contribute articles. That vision never materialized, but the time I committed writing and working on the project gave me a deeper understanding of the topics, and I’m still happy to share the work. This particular article was categorized ‘Level 2’.]
As we’ve discussed in other articles, money solves many of the problems associated with direct exchange, or barter. Rather than trading products, I can ‘trade in’ my livestock for its value in money. Money is more divisible than livestock (trading half of a live cow never works), and it’s also easier to carry around money from store to store. It’s easy to see that money always represents something. That dollar in your hand represents personally accrued value, whether it was by raising livestock or waiting tables.
In another article we discuss commodity monies, or currency that receives its value intrinsically (i.e. silver.) Silver has properties that are desirable aesthetically (jewelry) and materially (electronics production), and it is also limited in production, meaning there is a limited amount of silver that exists on the earth. Silver’s limited nature is the source of another form of value–marginal value. If there are 10 ounces of silver in the world and you own one of those ounces, you own 10% of the silver supply. That’s quite substantial! However if there are 100 ounces of silver in the world, one ounce of silver is merely 1% of the silver supply–not so valuable as 10%! An item’s value is determined in part by how much of it is available. Copper is not as valuable as gold because there is much more copper in the earth. Commodity money is, therefore, money which receives its market value primarily through its intrinsic value.
But if the United States ‘greenbacks’ currency is made from paper, not gold, where does it get its value? Enter: the Fiat. From the latin phrase, “let it be” or “let there be”, Fiat is an authoritative mandate regarding something (in the Latin Bible God’s statement, “let there be light” is ‘fiat lux’.) Fiat money, then, is money that has been issued or created by government mandate. Fiat money could be anything. The government might determine by fiat that glass beads are money. Likewise, they might decide that gold and silver are to be used as money. Either way, the important thing to note is that a fiat decision regarding money is top down instead of e pluribus, out of the many.
Since commodity monies arise naturally out of the needs of the market and receive their value based on intrinsic characteristics, government fiat is almost only used for introducing paper currency or other intrinsically valueless monies into the market. For this reason fiat money is often used antonymously with commodity money. By definition, fiat currencies are unnatural, as they require the mandate and enforcement of the government in order to exist.
So what is so desirable about fiat currency? Why mess with the natural development of commodity monies? Well, fiat currency allows the government to have a great amount of control of the economy. Since fiat money is intrinsically valueless, it can be printed quickly and cheaply, in contrast to gold and silver which require time and resources to mine and mint. The ability to print money allows the government to control the rate of inflation or deflation (read Bernanke’s speech from 2002), and it also gives it the ability to print out money for itself in times of financial hardships such as war or depression.
Depending on your view of the ethics of inflation, fiat money and the ability to print money could be good or bad. In another article on inflation, you can read about the implications of inflation and the way it affects the economy.
When was the fiat money system brought to the west? As recent as 150 years ago. For more information on the history of fiat currencies, check back for more articles.
For a more visual description of Fiat Currency, watch this video presented by Dominic Frisby:
[youtube http://www.youtube.com/watch?v=hx16a72j__8]
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