Fiat money is one of three basic types of currency. Commodity money has intrinsic value in itself—a piece of silver, a diamond, or a goat. When commodity money is used, it’s basically a barter transaction. Representative money is more like a promissory note. The issuer says the coin or note represents a reserve of specie, usually silver or gold, and can be redeemed in kind.
What Does “Fiat” Mean in Economic Terms?
The dictionary defines a fiat as an authoritative or arbitrary order. The term can cover a wide range of actions, from a parent setting a child’s bedtime to a government telling its citizens how fast they can drive their Fiats. When applied to currency, it means that the issuing entity says their currency is money simply because it says so. Sometimes it works, sometimes it doesn’t.
When Did Fiat Money Begin?
The first known use of fiat money was banknotes issued by the Yuan dynasty in China around 1000 AD. After explorer Marco Polo brought the concept back to Europe, several governments, including England, Sweden, and Spain, experimented with it as temporary measures when supplies of gold and silver were scarce, but most were abandoned when inflation threatened. Paper money continued to be issued as a convenience, but as convertible currency redeemable for gold or silver on demand.
When and How Did Fiat Money Become Widespread?
As international trade grew, most major nations agreed to peg their currencies to gold, creating what became known as the Gold Standard, which was widely adopted in the mid-19th century. But the Gold Standard had a relatively short life. After World War I, borrowing for repairs and economic growth made redemption of currency in bullion impossible for countries like Germany, which was saddled with massive reparations in addition to its own recovery efforts. The Weimar Republic issued unbacked currency, which led to hyperinflation and near collapse of the nation (and an attempt at recovery which ended badly).
The solution among the WWII Allies was reached at the Bretton Woods Conference of 1944 at which the International Monetary Fund was created along with a host of complex agreements that essentially tied member nations’ currency to the U.S. dollar at $35 per ounce of gold held in reserve by the U.S. Treasury. That ended in 1971 when President Nixon unpegged the dollar from gold, making it and nearly all other currency fiat money with floating exchange rates.
Is Fiat Money Real Money?
It’s said that U.S. money is backed by “the full faith and credit” of the United States. Essentially what the government is saying is that the nation has enough assets to back up its money and debts if forced to do so. That makes its money real to the extent you believe that to be true. Fortunately, it probably is. On the other hand, people in places like Iraq, Zimbabwe, and the Confederate States of America learned differently. As their economies collapsed, their money became worthless.
Are There Any Strong Fiat Currencies?
When it comes to currency, strong is a relative term. If you look at historical averages, it takes a fiat currency 27 years to become worthless. If you take 1977 as the year the world “went fiat,” the dollar, British pound, and Swiss franc have beat the odds.
But a closer look reveals that the British Pound Sterling isn’t quite as sterling as it used to be. When it was introduced in 1694, the pound was equal to 12 ounces of silver. At today’s silver prices, that would amount to about 220 U.S. dollars. But the exchange value of a British pound is more like $1.25. The truth is that this “strong” fiat currency has lost over 99% of its value since its inception.
When President Nixon unpegged the dollar, it was valued at 1/35 ounce of gold. Today a dollar will buy about 1/1300 of an ounce, a 37-fold decrease in purchasing power over the 50 years it has been a fiat currency.
But even gold and silver are only worth what people say they are, and they fluctuate in value too, so maybe there’s a little fiat in them. Nonetheless, the reality is that precious metals have held their value much better over time than fiat currencies have. Maybe it’s just because we say so, but we’ve been saying that for over a thousand years and haven’t been proven wrong yet.
What’s the Choice?
If you think that governments will keep driving their fiats until they run out of gas, perhaps you should look at putting your wealth into tangible commodities like bullion or land or goats. Each comes with its own issues, though. Land is difficult to move and goats need to be fed. Large amounts of gold and silver are cumbersome, but at least with bullion, it’s relatively easy to convert to cash when you need to.
The Great American Coin Company® has many options for investors. Browse our site for bullion coins and bars and more!