April 19, 2021

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Meaning of Fiat Money and Key Explanations

Meaning of Fiat Money and Key Explanations
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Fiat money is a widely used currency. The U.S Dollars and Nigerian Naira are examples of it. This type of money successfully replaced the commodity money. In this article, definition, explanations and problems of this money is discussed. Another name for it is paper money.

Definition of Fiat Money

Fiat Money is a type of currency not backed by gold but by government law. The term Fiat means a degree or an order. Therefore, it is a currency that exists as a result of an order by the government of a country to use such currency as legal tender. This money does not have intrinsic value attached to it.

Key Explanations

A type of currency. There are other types of currency. Commodity money, fiduciary money and digital money are part of it. Currently and all over the world, Fiat is the only recognised money. In fact, any effort to introduce other types of money like cryptocurrency is facing a lot of setbacks for the moment.

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Not backed by Gold. This money is not backed by gold. This means that it cannot be exchanged with gold. In those days, Fiat currency was backed by Gold. If you hold paper money, say the U.S Dollar, because it is backed by gold you can easily convert it for gold. Later on, the U.S government decided to remove the gold value in it. This makes the currency total flat with no value in it.

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Backed by Government law. The value of the money is based on government backing. It is the state that has ordered the use of such currency. Plus it is the only recognized form of money. Therefore, within the country boundaries that is what is used as a medium of exchange.

Legal Tender. The money is legally used as a medium of exchange within the legal territories of the country in questions. By legal tender it means that it is generally recognized for the payments of goods and services. The United States Dollars can mainly be used in the United States and not in Mexico. Also, the British Pound Sterling can only be used in British communities and not in China. Same is the Nigeria Naira.

No intrinsic value. Fiat Money does not have intrinsic value. This means that the value of the currency is less when compared with the value written on the face of it. All paper money is Fiat. The value of the paper is small when compared to the value written on it. The value of the paper of a 100 Naira note cannot be compared with the face value. What is used to make paper notes are infinitesimal to the value written on it.

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Problems with Fiat Money

Fiat money seems like the best money right now because it can easily be controlled by the government. However, it has major problems.

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It is centralized. Fiat currency is centralized. This gives the government too much power to do whatever it wanted with the currency. The state usually established a federal reserve or a central bank to keep an eye on the supply of the money within the country. However, the politicians used the money approved for projects for their personal use leaving the poor to their tents

It is not universally accepted. It cannot be accepted across borders. Before, you can use it across borders. A rate of exchange may be applied. This limits the value and makes many country’s currencies with little value compared to others. It also leads to inequality between people as 1 Naira in Nigeria worth less compared to that of many other countries.

Unlimited Quantity. Government can only control the supply of paper money and not demand. As a result, it may print more currencies that are needed or demanded by people. When this is the case, two problems arised. Inflation and inequality.

It causes inflation. Paper money causes inflation in turn worsening economic conditions especially per capita income. If more money is printed without huge demand to back it up, inflation set in. In some cases, it may lead to hyperinflation if not immediately curtailed through policies such as the Central Bank monetary policy or the government fiscal policy.

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It keeps the rich richer and the poor poorer. Paper money does not promote equality. Only the wealthy class has major control over it. The politicians also hold a large portion of it. And had hold on to it so that it won’t get to the masses. Also, politicians make sure that the poor don’t get it unless they push their guts higher. This enabled them to have greater control over the poor.

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Conclusion

Fiat or paper money are government backed currency. It supports the paradigm shift discussed in a previous article, people shift their trust from commodity to government. Fiat comes with its problems inflation and inequality are just a tip of it.

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