Fiat money refers to the money which is declared to be a legal tender by a particular government. Fiat money’s worth comes from the fact that the government has accepted it for paying of taxes and it has given permission for fiat money to be used in the form of a tender within a country for payment of all debts.
In places where fiat money is being used in the form of currency, it is called fiat currency. The U.S dollar, the Euro, Pound Sterling and Yen are examples of fiat currency.
Societies in the past were dependent on monetary systems where currency that was used in trade practices was commodity money (consisting of gold or other physical commodity) and representative money (which could be exchanged for a specific amount of some physical commodity). The represented commodity was either gold, silver or may be copper.
Fiat money’s value is not related with a physical quantity. Thus a coin which contains valuable metal can be considered as a fiat currency provided the face value is greater in comparison to its market worth as metal. An exclusive feature of fiat money is its acceptability by the government for paying taxes and other charges.
Fiat money and legal tender
A standard method followed by a government in order to create fiat money is to proclaim banknotes, produced by a bank which is government backed, as a legal tender or offering. This means that banknotes can only be legally offered for debt settlements. The debt cannot be paid with any other form of money. This concept has been criticized by many. Since paper money is considered fiat money or “real money”, then how come we are able to pay off our tax debt with checks, debit cards and credit cards? The questions raised here is, if the checks or credit cards are not considered legal tender, then why were these created at all in the first place?
In the year 1836, then American President went to the extent of passing the Specie Circular which provided for all payments to be made in gold or silver in relation to government lands. Fiat money has been blamed for giving rise to inflation and allowing countries to initiate and prolong war. Among several advocators for specie like gold, silver and bimetallic standard, the word “fiat money” is frequently used in a derogatory sense.
When can fiat money lose its value?
Generally, a fiat money currency tends to lose its worth when the government which is the issuer, does not guarantee its worth through taxation. However, a powerful private banking system as well as population consensus usually prevents this from happening.
Meaning of fiat money in monetary economics
In the field of monetary economics, fiat money refers to an innately useless good that is used for paying and is an object which is storable. In a few micro – founded monetary models, fiat money takes birth endogenously, since it makes certain trades possible which would otherwise not have been possible.