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Daan Wesdorp15 July 2024
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Fiat money explained
Autor: Daan Wesdorp
Date: 12 June 2024
Update: 12 June 2024 Reading time: 4 min
Fiat money explained
In the financial world, the term "fiat money" is frequently heard. We provide an explanation of this term and delve into how fiat money operates. We examine the characteristics of fiat money, explore its history, and discuss various alternatives, including cryptocurrencies.What is fiat money?
Fiat money is a currency issued by a government that is not backed by physical commodities like silver and gold. Its value is derived from governmental decrees that establish it as legal tender. Fiat money is accepted for transactions based on confidence in the economy and the stability of the government.
Characteristics of fiat money
The value of fiat money is heavily influenced by public trust in the issuing government's stability and reliability.An important characteristic of fiat money is that it allows governments to control monetary policies to stimulate economic growth. Governments can stabilize the economy and manage inflation by regulating the money supply, enabling more flexible responses to economic crises.
The history of this system
Fiat money was introduced to overcome the limitations of the gold standard, where the amount of money in circulation was directly linked to a country's gold reserves. This fixed supply often restricted economic growth.
Particularly in the latter half of the 20th century, after World War II, many countries transitioned to fiat money to minimize these constraints. The complete abandonment of the gold standard in the United States in 1971 marked a significant milestone, leading to the international adoption of fiat money. Central banks manage fiat money through monetary policy instruments.
How does fiat money work?
Fiat money is created by central banks that manage monetary policies, adjusting interest rates and issuing or withdrawing currency from circulation. This manipulation influences the amount of money available in the economy, directly impacting economic development and inflation rates.Exchange rates of fiat money in currency markets are determined by supply and demand, influenced by factors such as political stability, interest rates, economic performance, and speculation.
Criticism and debate surrounding fiat money
Despite its advantages, such as flexibility in monetary policy, fiat money is subject to criticism and debate due to inherent risks and disadvantages. A significant concern is the potential for government abuse, such as excessive money printing leading to inflation or hyperinflation. This not only devalues the currency but also destabilizes the economy.Risks of hyperinflation
One of the biggest risks of fiat money is hyperinflation, a situation in which prices of goods and services rise extremely rapidly, leading to a rapid decline in the currency's value.When a significant amount of money is printed to address an economic crisis or to finance debts, it erodes confidence in the currency. This erosion ultimately triggers hyperinflation.
Citizens then require large amounts of money to meet their basic needs. A notable historical example of hyperinflation occurred during the Weimar Republic in Germany.
Alternatives and cryptocurrencies
In response to the shortcomings of fiat money, alternatives have emerged, including cryptocurrencies. Bitcoin and Ethereum are well-known examples of virtual or digital currencies that verify and secure transactions through blockchain technology. These cryptocurrencies have limited supplies, providing protection against inflation, and operate independently of central banks or governments. Cryptocurrencies have gained popularity as transactional and investment tools, offering a viable alternative to traditional fiat money.
This comprehensive overview highlights the intricacies and dynamics of fiat money, its historical context, and evolving alternatives in today's financial landscape.
Disclaimer: The Silver Mountain does not provide investment advice and this article should not be considered as such. Past performance is no guarantee of future results.
Over Daan Wesdorp
Manager Inkoop Edelmetaal | Stocks, cryptocurrencies and precious metals
Rolf van Zanten
Nederlands