What is Fiat Money?
Fiat money is the currency that is announced as valid for payment by the government. But it has no fixed value. It isn’t a material possession like gold or silver. The value of a fiat currency is guaranteed by the government as they issue the money. The government can control the supply of this currency depending on the economic situation. Fiat currency will lose its value if a country becomes bankrupt.
Most of the paper money moving around the world is fiat money. The most popular fiat currencies are the Canadian dollar, US dollar, euro, Japanese yen, and Russian ruble. Almost all the national currencies are fiat currencies.
The Latin word “fiat” is mostly described as “it shall be” or “let it be done.” The value of fiat currencies is exclusively protected by the government so fiat money has no permanent worth.
Before the invention of fiat money, governments would either issue paper money that could be the medium of exchange for a fixed quantity of a tangible good or manufacture gold or silver coins.
Types of Money
Money has the same attribute throughout all the time but it has always been used in different forms. Additionally, Money can be categorized into three forms. Those are:
Commodity: It is the oldest form of economic tool. Before fiat money, commodity money was used for making transactions. Salt, beads, seashells, tobacco, silver, and gold, were considered commodity money. It has a tangible store of value and it can be seen and touched. That’s why it was more trustable by the users.
Fiat: During the Chinese Tang dynasty in the 11th century, fiat money was invented in the form of a piece of paper. Each piece of money is authorized by the government. It gets value from the governments that create faith in individuals and businesses. Till now it is the most used and the most popular form of money for making transactions.
Representative: Representative money is produced by the government as an alternative to a commodity or fiat currency. Representative money includes checks and credit cards. Usually, representative money is used when the user is willing to pay later.
Is Cryptocurrency a Fiat Money?
Cryptocurrency is not a fiat currency as it is not issued and authorized by a government. Bitcoin and other cryptocurrencies are controlled by blockchain technology. No single authority can control the value of cryptocurrencies. Cryptocurrency is a digital currency with a limited amount of supply.
A cryptographic computer networking technology, Blockchain is used to create the majority of cryptocurrencies. It allows them to spread without the help of a central authority like the Federal Reserve. Governments are free to incorporate cryptocurrencies and related technology into their national currency systems. El Salvador is the first country to accept Bitcoin as legal money. Furthermore, China is also creating a digital version of its yuan currency.
The majority of cryptocurrencies get their value from various sources because they aren’t supported by central banks. Additionally, the price of cryptocurrencies about the dollar has been explosive because many investors are speculating on their potential value.
Advantages of Fiat Money
Today, fiat currency is the most popular currency in the world. As fiat money is not a fixed resource like gold, and the government has much greater control over it, which gives fiat money the power to manage economic variables such as credit supply, liquidity, and interest rates. There are many advantages, such as:
- It is the most popular form of trade
- The power of money supply avoids shortage issues
- Governments can use fiat currency in response to quick economic changes.
- The value of a fiat currency is more stable because the value does not depend on the value of a physical asset
- It is more convenient to use
- it is more cost-efficient to produce
Disadvantages of Fiat Money
However, fiat currency is the most popular worldwide but there are a few drawbacks as well.
- The higher amount of supply can lead to inflation.
- It may lose value during inflation.
- It is tied with faith in the nation’s currency. If people lose faith in it, it will lose its value.
- Fiat currency does not have any natural value
- Political instability can affect the value of fiat currency
Why Fiat Money is Valuable?
The faith and trust in the government make fiat money so popular among users. There are many reasons why fiat money is still more valuable. One of the strongest reasons is government’s demand that you pay taxes in the fiat money they issue. Since everybody has to pay taxes so people accepted it as a form of exchange. Besides those, you can use fiat money not only inside the country but outside as well. You can trade one country’s fiat currency with another at a foreign exchange rate.
Currently, Norwegian krone is considered to be the safest fiat currency because Norway has zero debt. Norway’s economy is quite stable compared to others. Other safe currencies are the Japanese yen, Swiss franc, and the United States dollar. The United States and Japan have strong positions in the global economy. It ensures that their currencies will recover more quickly from economic hardship than any other country.
Fiat Money and The Risk of Hyperinflation
When a country experiences quince and uncontrollable price increases of goods and services it is called hyperinflation. When a nation’s monthly inflation growth rate surpasses 50%, it is referred to as hyperinflation. Excessive fiat money printing by central banks is one of the major drivers of hyperinflation. To try and boost the economy, the government creates additional money. Bank lending is promoted, which in turn encourages consumer spending and increases business borrowing. However, the value of money decreases as more is printed by the government. Supply and demand spiral out of control, and the economy suffers as a result. Although it is very uncommon.
Fiat Money and Digital Currencies
Some disadvantages of Fiat Money led some individuals to look for digital currencies. Here comes the demand for digital currencies like crypto. During the COVID-19 pandemic, the necessity of digital currency was noticed by everyone. The pandemic has also influenced us to use digital payments. In developing economies, over 40% of adults made online payments in stores using a card, phone, or the Internet.
Considering the demand and the Canadian’s use of digital transactions more frequently, the Bank of Canada is thinking of launching a central bank digital currency or CBDC. It is a digital form of fiat money which is Informally called a Gov Coin. CBDC is regulated by the country’s central bank and considered legal. CBDC will operate within a system so digital transactions will be more secure and reliable.
But it will not be launched yet. The Bank of Canada says they do not see the need for a digital currency right now but they are studying the issue that Canada may need one in the future.
Fiat money holds its value from supply and demand. Governments use fiat money to create economic stability and help protect the business cycle from unwanted incidents. But the oversupply of fiat money can create inflation or even hyperinflation.
However, Fiat money is more stable compared to other forms of currencies. This stability allows lenders and investors to make sound decisions.