Fiat Money

Fiat money is a government-issued currency that is not backed by a physical commodity, such as gold or silver, but rather by the government that issued it. The value of fiat money is derived from the relationship between supply and demand and the stability of the issuing government, rather than the worth of a commodity backing it. Most modern paper currencies are fiat currencies, including the US dollar, the euro, and other major global currencies.

The term “fiat” is a Latin word that is often translated as “it shall be” or “let it be done.” Thus fiat currencies only have value because the government maintains that value; there is no utility to fiat money in itself.

Fiat currency came about when governments would mint coins out of a valuable physical commodity, such as gold or silver, or print paper money that could be redeemed for a set amount of a physical commodity. Fiat, however, is inconvertible and cannot be redeemed simply because there is no underlying commodity backing it.

Because fiat money is not linked to physical reserves, such as a national stockpile of gold or silver, it risks losing value due to inflation or even becoming worthless in the event of hyperinflation. In some of the worst cases of hyperinflation, such as in Hungary immediately after WWII, the rate of inflation can double in a single day.

Furthermore, if people lose faith in a nation’s currency, the money will no longer hold value. This is much different from a currency backed by gold, for example; it has intrinsic value because of the demand for gold in jewelry and decoration as well as the manufacture of electronic devices, computers, and aerospace vehicles. The US dollar is considered to be both fiat money and legal tender, accepted for private and public debts. Legal tender is basically any currency that a government declares to be legal. Many governments issue a fiat currency, then make it legal tender by setting it as the standard for debt repayment.

Earlier in US history, the country’s currency was backed by gold (and in some cases, silver). The federal government stopped allowing citizens to exchange currency for government gold with the passage of the Emergency Banking Act of 1933.

 The gold standard, which backed US currency with federal gold, ended completely in 1971 when the US also stopped issuing gold to foreign governments in exchange for US currency.

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