Fiat Money

What is Fiat Money/Fiat Currency?

Fiat Money is the currency which is declared as the legal tender by the government and has no backing of the physical commodity like gold and rather the value of the fiat money is derived from the demand-supply relationship in the market. The India Rupee and US Dollar are the fiat currencies of India and America, respectively. The face value of fiat currencies is far high than their commodity values. Most of the modern paper currencies of the world are fiat currencies.

Example of the Fiat Money

• Australia – Australian Dollar
• Belgium – Euro
• Chile – Chilean peso
• China – Chinese yuan
• Finland – Euro
• India – Indian rupee
• Mexico – Mexican peso
• New Zealand – New Zealand dollar
• Oman – Omani rial
• Saudi Arabia – Saudi riyal
• South Africa – South African rand
• Uganda – Ugandan shilling

Advantages of the Fiat Currency

There are several different advantages of Fiat Money. Some of the advantages of fiat money are as follows:

1. The fiat money has a stable value, unlike money which is based out of the commodity like gold, silver or copper, etc. as the currencies which are based out of the commodities are volatile due to regular business cycleBusiness CycleThe business cycle represents the expansion and contraction of the economy that occurs due to ups and downs in the gross domestic product (GDP) of a country. It is experienced over the long term and goes parallel with the natural growth rate.read more and the periodic recessions. On the other side, the central bank of the country can print or can hold the paper money when they require which gives them good control over the supply of the money, interest rates, and liquidity.
2. Fiat currency is the most accepted currency form and it is supported by the multiple currency exchanges and payment networks around the world. This makes the fiat money valuable.
3. It helps in stabilizing the economy of the country for the reason that governments of the country have control over the supply of the money and fiat currency is not based on the volatile commodity.

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Source: Fiat Money (wallstreetmojo.com)

Disadvantages of the Fiat Money

Apart from the advantages, there are some limitations and drawbacks as well of the Fiat Money which includes the following:

1. Although it is viewed that the fiat currency is the more stable currency which can help in the situation of the recessions but during the global recessionGlobal RecessionGlobal recession refers to a condition when the countries across the globe experience an economic downturn for an extended period. It is a form of synchronized economic downfall encountered by the various interrelated economies throughout the world.read more it was argued by the critics that a limited supply of gold makes it a more stable currency when compared with the fiat money as it has an unlimited supply.
2. Another disadvantage of the fiat currency is the potential that its value can go zero because the paper in which it is printed has no value due to which all value can be lost. Once the value of the currency starts going downwards towards zero, then the economy of the country and everyone using the currency will completely get ruined.
3. As the government is given the power to print the fiat currency whenever they want, it gives the option to the government to steal the resources of the people of the country even in case they refuse to get taxed. In that case, the government slightly inflates the currency and then buy whatever is required by them before the rise in the prices.
4. Every year a new bunch of money is printed for the purpose of replacing the bills which are taken out of circulation because they have been lost or destroyed. But using this reason generally more currency is printed than the actual requirement of the money, thus causing the fiat currencies to lose their value over the period of time.

Important Points

1. This is the currency that is issued by the government and is not backed by any of the commodities such as gold, silver, etc. It gives control to the central bank of the country over the economy as they can print the fiat currency according to their requirement i.e., as and when required by them.
2. Fiat currency serves as a good currency in case it can handle roles that are required in the economy of the nation for its monetary unit like storing value, enabling the exchanges, and providing the numerical account.
3. The fiat currency may lead to the situation of hyperinflationHyperinflationHyperinflation is an accelerated level of inflation that tends to quickly destroy the actual value of the local currency since there is a rise in the cost of all products and services. It forces people to lower their holdings in that particular currency to participate in stable foreign currencies.read more in the economy as the government of the country might print too much fiat currency
4. Most of the modern paper currencies are fiat currencies including the U.S. dollar.
5. The material using which the fiat money is made out of does not determine its value which means that the metals which are used to mint the coins and paper used for the bills do not have the value of them. Value of the fiat money is known from the relationship between the demand and supply in the market and from the stability of issuing government, rather than from the value of a commodity by which it is backed.

Conclusion

Fiat currency is the most accepted currency form and it is supported by the multiple currency exchanges and payment networks around the world.  In other words, fiat money does not have any intrinsic value and the market forces determine its value. This helps in stabilizing the economy of the country for the reason that governments of the country have control over the supply of the money and fiat currency is not based on the volatile commodity. However, the government must be very careful while printing the fiat money as in case the over-circulation value of the currency would drop and may also lead to the situation of hyperinflation in the economy. Governments introduced fiat money as the alternative to the representative and the commodity money.

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