The history and use of the fiat monetary system

The term fiat money is employed to define as hardly any money declared by way of a government to be legal tender without commodity backing. Legal tender simply means that there is a law requiring everyone to simply accept the currency in commerce. Besides, fiat money was state-issued money which is neither fixed in value in terms of any objective standard, nor legally convertible to anything else that was demanded by another person. In other word, fiat money is money without intrinsic value. In ancient times when money was not invented trade all together was on barter system. "Barter" basically methods to purchase something you want with products or services instead of paying for what you want with money. Under this technique, exchange only may take place between two persons only when each possesses the goods which the other wants. As an example, imagine you grow tomatoes and your neighbor grows corn. It is possible to imagine a scenario where you as well as your neighbor consent to trade 25 pounds of your tomatoes for 25 pounds of his corn. Barter system will cause one party needed to suffer by the end of trading because there is no measure of value, even if two people met together who wanted each other goods, they could not find a satisfactory equilibrium price. This situation can be explained when you yourself have each paid for what you would like with something other than money. This technique was possible only in a straightforward economy but following the development of economy, direct exchange of goods without the utilization of money, had not been without defects. Despite the fact that barter was limited in its usefulness, it played a major role in developing the concept of money.

The term fiat money derives from the Latin fiat, meaning "allow it be done", which mean that money ordered into existence with a sovereign power as the money is made by government. Where fiat money can be used as currency, the word fiat currency is used. Today, most national currencies are fiat currencies, including the US dollar, the Euro, and all other reserve currencies, and also have been since the Nixon Shock of 1971. The word Nixon Shock is utilized to refer the two different policy measures taken by U. S. President Richard Nixon in 1971 and 1972 that eventually resulted in the collapse of the Bretton Woods system of international financial exchange. The Bretton Woods system dissolved between 1968 and 1973. The U. S. President Richard Nixon was announced the "temporary" suspension of the dollar's convertibility into gold in August 1971. While the dollar had struggled within the parity established at Bretton Woods, this crisis marked the break down of the system. An effort to revive the major currencies commenced to float against each other by March 1973 and the fixed exchange rates failed. The policies imposed and the actions taken by President Nixon included imposing a 90-day wage and price freeze in the us, a 10% import surcharge and, especially, closing the gold window, effectively making the U. S. dollar inconvertible to gold.

The term fiat money is used to spell it out currency that is employed because of a government's order, that the currency must be accepted as a means of payment. For example, for the U. S. , the dollar is fiat money as well as for Nigeria it is the naira. The gold standard is not currently employed by any government of the country when you compare with fiat money. Britain stopped using the gold standard in 1931 and america abandoned the system in 1971 due to the economic depression. Economic downturn result from the declines in the amount of money supply induced by adherence to the gold standard. Under this example, Britain and United Stated leaving gold earlier in order to have been able to all the worst of the Depression and start an earlier process of recovery. Based on our research, the finding that the time at which a country left the gold standard is the main element determinant of the severity of its depression and the timing of its recovery has been shown to hold for literally dozens of countries, including developing countries. The gold standard was completely replaced by fiat money.

There is one major difference as it pertains to the standard price of fiat money and the standard price of gold. This difference is the quantity of stability. The worthiness of the amount of money is decided based on the confidence shown by the individuals instead of the face value. As a result, there is very little stability in case there is fiat money. However, this confidence level is bound to keep varying from time to time and hence the worthiness of the amount of money would also vary every now and then which would turn out to be disastrous for just about any economy. Nowadays, the price tag on gold is determined by the demand for the metal, and although it is no more used as a standard, it still serves an important use. For example, gold is a significant financial asset for countries, central banks, and also employed by the banks in an effort to hedge against loans designed to their government. The stability of gold is one of the major reasons why economies of the world want to convert their paper currency into gold rather than opt for fiat money. Hence, gold standard wins over fiat money.

2. 6. 2 Characteristic of fiat money

Fiat money or fiat currency, usually called paper money, is a kind of currency whose only value is a government made a fiat as the amount of money is a legal approach to exchange. This means that money that for legal reasons must be accepted as payment of debt. Currency and coins are legal tender because they're created directly by way of a government and by governmental decree must be accepted. To make clear the legal approach to exchange, example like people may use one of this money to buy something they want to be able to meet their satisfaction. Fiat money make a trading become more successful if equate to barter system. Unlike commodity money or representative money, it is not located in another commodity such as gold or silver and it is not covered by a special reserve. Commodity money is kind of money with intrinsic value such as cows, corn, sheep plus much more. Besides, store of value is one of the characteristic of fiat money. Fiat money holds its value so long as holders of the currency believe that they will get an exchange partner for it at some later time. On the other hand, modern paper currency, coins, and checkable deposits are also regarded as fiat money.

Moreover, fiat money does not have any intrinsic value and the return of fiat money is anything other than the confidence holders have throughout the market which included in the government. The government decrees the fiat money to get value. Furthermore, the values of fiat money derive from the expectation of later use or the willingness of people to simply accept fiat money as a medium of exchange. More clearly, the worthiness of fiat money comes from the public's general willingness to simply accept it in trade for other goods. This willingness is basically will depend on the public's confidence in the authority usually the federal government when issuing the fiat money. Fiat money is not valuable into itself but it is valuable for what it can purchase. In year 2004, the currencies on the planet are fiat monies. People about the world began to buy goods and services with fiat money. However, the problem with major currencies including the euro, america dollar and the Swiss franc is more technical.

Furthermore, Fiat money emerged from commodity money when people realized that value used was not a requirement for a medium of exchange. It is hard for everybody to doing their business by using commodity money because they're unable to gauge the value of commodity money when comparing with fiat money. Leaving money with value used made it possible to utilize items that better fit the durability, divisibility, transportability, and non counterfeit ability characteristics of money.

In addition, fiat money becomes most important to modern economies. It is because that fiat money can help to control business-cycle instability in the country when increasing numbers of people start using fiat money in exchange with other goods and services. Fiat money gives rise to the active use of monetary policy. Besides, it is more convenience and easy for us to bring along if compare with commodity money. For example, people do not need to to bring the cows to other party in exchange with the nice they want when they begin using fiat money. Finally but not least, fiat money can simply managed by the issuing authority. It can benefit visitors to determine the top class and lower class people in a society. Lastly, fiat money also avoids unanticipated and uncontrollable fluctuations in the value of commodity money, which can wreck havoc on the economy, that result from market shocks of the commodity.

Money by Decree

The word fiat is originated from Latin word that brings a meaning associated with an arbitrary order or decree, such as what government might lay down. The federal government set the fiat money as legal tender and from the rule set by government, its mean that fiat money has value as money. Besides that, government issues an order, decree, or law stating that fiat money is valuable. This statement can only just being work is rely upon the amount of men and women who regularly violate other government laws and decree. In addition, it also work when government decree that folks may use fiat money to pay their taxes. Any item that is accepted by government for tax payment is well coming to being the generally accepted medium of exchange.

Two Values

There are two kind of value that can help us to better understand the fiat money as well as how to differentiate fiat money from commodity money which is value in use and value in trade.

Value used: This type of value and therefore the satisfaction of consumer toward wants and needs is provided by the direct consumption of goods and services. The extreme goal of economic activity is acquiring value from the utilization of goods and services. Value used is the ultimate step in the production, allocation of purchase price, and consumption activities that are undertaken to handle the basic issue of scarcity. This value is necessary in order to avoid the expensive of startup cost and risk. Besides, the term should be differentiated from market value and value in exchange to avoid the confusion in the market place, which understands fair market value to reflect the value on view market.

Value used pricing => It really is a predicament where establishing a cost based on a product's value to the client instead of the manufacturer's cost of production. This technique of pricing is effective only when consumers have no effective substitutes. For instance, a pharmaceutical company may price a specialty cancer drug at a very high level, whatever the firm's cost of production, based on the drug's value to the limited number of individuals who have few alternatives. Alternatively, something may be sold at less price due to competitive pressures because of the product has a very high value for many people.

Value in trade: This is a value an item, especially money, can be traded for other goods and services that may then be utilized to meet wants and needs. Value in trade mean that value that is satisfaction, is obtained indirectly through the acquisition os another thing. For something to possess value in exchange it do not need to have value used.

As a conclusion, fiat money has value in exchange, but little or no value used. In contrast, commodity money has both values used which is on the commodity part and value in exchange which is on the money part.

The Emergence of Fiat Money

In the transformation from commodity money to fiat money seems clear, a logical next step in the historical progression that moved from self-sufficiency to barter to commodity money. However, the separation of value in trade from value in use was a major conceptual breakthrough that made continued monetary progress possible. Human made the transformation from commodity money to fiat profit three steps:

Fully Backed Paper Currency: This was the first rung on the ladder of transition from commodity money to fiat money. Under this step, the paper currency issue was backed completely by the commodity money, which at this stage of development was usually gold or silver. Basically, this paper currency might have been traded for equivalent amount of gold or silver, that was cautiously hid away in a safety location. As an example, the United Stated issued gold and silver certificates in return by actual amounts gold and silver stored in large storeroom. However, the general public took to using paper currency within the actual commodity money because the paper currency generally fit the money characteristic better than the metal, especially transportability.

Paper FOREX Rate: The second step was the achievement by the amount of money issuer that very few people actually traded paper currency for commodity money. Actually, there is very few people used gold or silver as money due to it problem occur in commodity money. The public willing to used paper currency as the medium of exchange. Which means that the amount of money issuer do not need to to maintain an definite equality between your amount of the commodity money hideaway and the amount of paper profit circulation. For example, they could have $10 billion worth of paper currency which will backed by only $1 billion worth of gold. In nature, the exchange ratio between your paper currency and the commodity money was really needed. They could set and fix the price tag on gold and the price of silver. In order that, if anyone wished to retrieve their currency for gold or silver, they could have done so at the fixed prices.

Fiat Paper Currency: This is actually the third part of transform commodity money into fiat money. This task are apply in order to full-fledged fiat money was easy once people grew cozy using paper currency rather than the actual gold or silver commodity money. The price of commodity money will stopped fixing because of the money issuing authorities. Disconnecting the price of the commodity from the worthiness of the fiat paper currency meant that the amount of money was no more backed by the commodity money which is silver and gold. The paper currency wan said as valuable by the federal government is be based upon the decree of government, its general acceptability, its ability to acquire goods and services. In addition, this also made it easier for the money issuing authority to regulate the quantity of money in circulation.

Modern Fiat Money

Paper currency was the first kind of fiat money widely employed by people in traded goods and services. Modern fiat money comes in four basic varieties which are paper currency, metal coins, checking accounts, and electronic money.

Paper Currency: This currency involves bits of paper, and is normally issue by government or central bank authority. This type of money consisting of printed paper that can circulate as a substitute of specie. For instance, the Federal Reserve System in United Stated has issued $1, $5, $10, $20, $50, $100 bills. On the other hand, paper currency was also issued by the U. S. Department of Treasury, some state government, and more than a few private banks in the past. Paper currency is consider as fiat money because the worthiness in use of the paper, however the value in trade of the currency is merely on the small fraction.

Metal Coins: A coin is normally a bit of hard material, this include shiny metal and form in disc that make from relatively cheaply metals and metal alloys which is used as a kind of money. While metal coins have been around for centuries and it were an essential component of commodity money, modern use of metals for coins result predominately leads to fiat money. It is because that the value of metals found in the coins is less than the face value of the coins. The market exchange value of any coin come from its historic value and intrinsic value of the metal component. For instance, gold and silver. Sometime, metal coins that which serves as payment.

Checking Accounts: The checking account was the most common type of fiat profit modern economies, or even more precisely checking account balances maintained by banks. Checking account allow its customer quick access to the fund in those account by writing check and allow them to use this fund to pay bill and doing other financial transaction in the shorter time. Furthermore, the amount of money from bank checking account is two-part systems which consist of the lender account and the paper check. Basically, the balances of bank checking account are barely accounting entries in a bank's computer database. The power used to store this information has significantly less value used that the values in exchange of the fund in the lender account. Otherwise, the paper checks also less valuable than what the balances can buy. Lastly, the checking account pay interest sometime depend on how large the total amount in the account and the monthly service payment will be charge when the balance fall below a present-day level.

Electronic Money: This type of money is the emerging use of electronic bank-account balances without the use of paper check. These balances will access directly through ATM machines, debit card and also store computers. Besides, this electronic money also included within bank checking account balances because the computer technology are quickly transforming this money into a unique type of fiat money.

Paper currency metal coins bank checking account electronic money

2. 6. 3 How fiat money system work

In the fiat money system, the money is not backed by a physical commodity. Instead, the scarcity of fiat money and the fact that people seem to be to want it is the only thing that gives the amount of money value. Besides, people want fiat currency has been the main topic of much debate. For instance, if you were an alien and visiting the earth for the first time, you'd be amazed at how the earthlings seem to be to prize little bits of paper with paint on them.

Debt is one of the ideas that can use to explain the worthiness of fiat money. As an example, if you are in debt, you haven't any alternative but make an effort to obtain the pieces of paper in order to pay your debt, in case the paper is scarce, you have to compete for it. Interestingly, indebtedness appears to go together with fiat money, but that is not a conclusive evidence for this theory.

Moreover, another way that can be use to make clear the want for the money is that folks got used to paper money in the fractional reserve system. Once the metallic backing was removed, people continued to use money as they had become accustomed to. One argument for this thesis is that the fiat money systems which have worked best historically are the ones where the physical backing was removed slowly and secretly.

A third way to make clear the value of fiat money is that it's valuable because the government says so. This theory has often been tested in practice, and it could be rejected with confidence. Nevertheless, government still tries to inject value into paper by law and price control every once in awhile. This situation can not work over time and it usually lead quickly to another step, which is hyper-inflation. Hyper-inflation is the destination stage of any fiat currency. During hyper-inflation, money loose most of its value practically overnight. Besides, hyper-inflation occurs due to the increase regular inflation to the main point where all confidence in money is gone. Confidence is one of the important factors that use to look for the value of money in the fiat monetary system. After the confidence is gone, money irreversibly becomes invaluable, regardless of its scarcity. For days gone by 3000 years, the gold standard replaced every fiat currency.

Although a fiat monetary system often evolves out of an fractional reserve system, this is not always the truth. Sometimes the fractional reserve period has been skipped altogether. The Roman Empire is one of the very most popular example where in fact the silver based metallic system slowly but surely evolved into a fiat monetary system based on token coins. The silver content in coins was slowly lowered until coins consisted almost totally of tin. This situation took place over a period century, which is just about the longest lasting fiat monetary system in the history of the world.

In the fiat monetary system, there is absolutely no such physical restrain on the money that may be created. Whereas, in a fractional reserve system, the money that may be created is still limited by the quantity of metal available. This also allow unlimited credit creation. Initially, a rapid growth in the option of credit is often mistaken for economical growth, as spending and business profit grow and frequently there is a rapid growth in equity prices. Over time, the economy tend to suffer a lot more by the next contraction than it gained from the expansion in credit.

In most cases, a fiat monetary system comes into existence as a result of excessive public debt. When the federal government struggles to repay all its debt in gold or silver, the temptation to eliminate physical backing rather than to default becomes irresistible. This is the case in 18th century France through the Law scheme, as well as in the 70s in america, when Nixon removed the last link between the dollar and gold.

In addition, for fiat money to work, the government must demand it in payment of taxes and say that it be used as a tender to pay all debts.

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