Finance

Fiat Money

Fiat Money

Fiat money is a form of currency that has no intrinsic value but is recognized as legal tender by the government. It is basically a government or central bank guarantee that the currency can be exchanged for products of equal value. Hence, the value of fiat money is generally dependent upon the confidence of the public in the issuer of the currency, which is usually the government or central bank of the nation.

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What do we mean by Fiat Money?

Fiat Money is inconvertible paper money introduced as an alternative to commodity money (which has its own intrinsic value). China was the first to adopt it in 1000 AD, and the currency quickly spread to other countries around the world, gaining popularity in the 20th Century. This currency does not have its value linked to the price of an asset like gold or silver. It cannot be converted or redeemed and has it has its own intrinsic value. The pound sterling, the euro, and the US dollar are all examples of fiat money. In reality, only a few currencies in the world are pure commodity currencies, with the rest being a type of fiat money in some way.

How does it work?
Fiat Money is an alternative to the barter system. It allows people to buy products and services. Its value depends upon the country’s economic performance. For example, a country that is experiencing instability has weakened currency and inflated commodity prices which makes it hard for the people to buy the products. It is not supported by any physical commodity, but by the faith of the people and virtue of the government declaration. It acts as a storage medium for purchasing power. It allows people to buy and sell products and services. The value of Fiat Money is dependent on how a country’s economy is working. It is the opposite of Commodity Money. The word “Fiat” comes from a Latin word that means “ it shall be “ or “let it be done”.

Pros and Cons:

Pros:
• It serves as a good currency as it handles the national economy.
• It is not a scarce or fixed resource so a central bank has greater control over its supply and value.
• Government can increase the money supply which can stimulate economic growth.
• It is the most accepted currency and is supported by multiple currency exchange and payment networks around the globe.
• It is viewed as a stable currency.

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Cons:
• It can lead to hyperinflation. (i.e. government can print too much money)
• The material used to produce Fiat Money does not determine its value.

Notable Examples:
• India – Indian Rupees
• Saudi Arabia – Riyal
• Finland -Euro
• Australia – Dollars
• China- Yuan
• Mexico – Peso
• Dubai – Dirham
• Uganda – Shilling

Bottom Line: 

Fiat Money helps in stabilizing the economy of the country. The government must be careful about printing the money as it results in over circulation value of the currency would drop.

Author: Isha Patel

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