What is a fiat currency?
First of all, fiat according to the Oxford dictionary, means a formal authorization or proposition.
While currency is any form of money that is accepted as a medium of exchange and is currently in circulation. (See definitions of money and medium of exchange in the FAQ section at the bottom of this page)
Chao, the world’s first paper currency (China)
Now, currency is ANY form of money.
So, currency includes both:
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Money that carries only putative value such as paper money
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AND money that carries naturally-existing value such as silver and gold coins
Therefore, unlike many think, currency does not automatically mean paper money.
What is a fiat currency exactly?
Now, to put the two words together…
A fiat currency is basically when something with no intrinsic value and not backed up by any asset is made to be used as a medium of exchange (money) by a government order.
Past
A fiat currency is not something that has been around only for the last couple hundred years.
In fact, the first recorded fiat currency made of paper, chao, is over 750 years old. It was introduced in 1260s during the Yuan dynasty.
In the past the majority of fiat currencies were made of paper. Those that were not made of paper were made from easily-accessible and cheap metals (eg. iron and copper).
In general, in the past, many surprising and unexpected, at least for those living in the 21st century, items were used as currencies.
For example, seashells and salt. These items hold very little value today. However, in ancient times, seashells were limited in supply by long travels to the seaside. While salt wasn’t easy to find or extract from the ground.
Today
Today, first of all, the majority of currencies are fiat.
Second, all of them are made of paper.
In fact, today there are over 170 fiat paper currencies in the world.
Zimbabwe dollar collapsed in April of 2009
Now, since money with putative value is a fiat currency… That makes money with naturally-existing value to be a non-fiat currency. The difference between the two is huge.
Fiat currency is used only in geographical regions where it is agreed to be used by the governing bodies.
- For example, pound sterling is officially only used in United Kingdom and several small Crown-dependent regions.
While non-fiat currency, because it contains an internal value, is accepted everywhere.
- For example, gold, is accepted in 194 nations around the world.
Cleaning up Hungarian streets. Hungarian pengo turned out to be garbage after its collapse in 1946
It has a tendency to fail, sooner or later
Throughout history, more than 600 fiat currencies were used by various nations.
They share one aspect in common. All of them went through devaluation and eventually collapsed.
Based on the number of years each existed, the average life expectancy of a fiat currency is 27 years.
Why it fails
Any fiat currency is destined to fail earlier or later because, backed up by nothing, there is no intrinsic value in it.
The value of fiat currency is purely determined by:
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supply
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the amount of it available at any given time
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demand and
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the desire of people to use it
Now, a fiat currency doesn’t fail because of lack of supply. Because let’s face it, the amount of paper available to print the currency is basically unlimited.
The real reason behind its failure is lack of demand.
People eventually lose trust in something that is available in unlimited amounts and at any time can be doubled or tripled in circulation.
This is exactly what happened with Zimbabwe dollar in 2009, Swedish krona in 1992 and Hungarian pengo in 1946.
Conclusion
As a summary and to put it straight a fiat currency is ‘made-up’ money with artificially created value and, unfortunately, its collapse is inevitable.
You opinion and questions are welcome — leave them below.
Main references:
www.investopedia.com
www.naturalnews.com
www.oxforddictionaries.com
www.wikepedia.com
www.investorwords.com
www.thesovereigninvestor.com
FAQ
A fiat currency is basically when something with no intrinsic value or not backed up by any asset is made to be used as a medium of exchange (aka money) by a government order.
Money is any item or record that is accepted as a payment for goods and services. It must be a medium of exchange, unit of account (be measurable) and store value over time.
The instance when something is used as an intermediate when exchanging goods and services, it functions as a medium of exchange.
Well this is kind of scary. This kind of seems like where we’re heading. Our currency is basically worthless since the gold standard fell through and being that the federal reserve is a private bank it seems like one day we will be talking about our own fiat currency. I have thought about investing in gold but I don’t exactly know where to even begin or who to trust.
Hello,
Thank you for your comment. The US dollar though not worthless yet gradually loses its dominance as the main reserve currency.
History shows that currency of a country with the greatest economy and significant political power eventually becomes the global reserve currency.
For example, if you look back, before World War II, Britain had the strongest economy and practiced a considerable political dominance over its numerous dominions and colonies – and obviously the pound sterling was the global reserve currency at that time. However, the war had damaged Britain’s economy and political authority, and therefore after World War II, the pound sterling could no longer be the global reserve currency. On the other hand, the US economy, because of its limited involvement in the war and trade with the Allies, grew significantly – this allowed the US dollar to replace the weakened pound sterling. US since then has a status of the world’s greatest power, and although nowadays euro, pound sterling and the Japanese yen are also reserve currencies, the US dollar serves as the main reserve currency.
However, in the last few years the US economic and political dominance has been challenged by China. China now is the largest merchandise trader in the world; it also became a powerful geopolitical force in itself along with Russia, Germany, Iran, and Saudi Arabia. Chinese yuan on November 30 of 2015 has been added to the basket of reserve currencies and now stands along with US dollar, euro, pound sterling and the Japanese yen. In addition, on April 19 of this year China has introduced its gold-backed yuan with the warning that “there can be no conversion of gold-backed yuan to or from US dollars”. All these changes certainly have effect on US dollar.
Regarding saving in gold, like most people, you probably would not be able to afford to acquire gold in ounces or even 1/4 or 1/10-ounce coins or bars, so you should look at gold in small denominations or gram weights. Today, there are several companies offering LBMA gold in small denominations; some examples are Credit Suisse, UBS and Karatbars.
Personally, I chose Karatbars because the company offers a free gold savings account (without any monthly charges) where you can acquire gold in quantities as small as 1 gram. Your gold is either stored in vaults or shipped to you upon your request. In addition, you get small commissions on your own purchases and your referrals (commissions are much better if you become an affiliate). The Karatbars debit MasterCard allows you to convert gold into cash and vice versa. Although Karatbars gold per gram seems to be relatively expensive, it is cheaper in the long term. Read my review on Karatbars here.
I am working on putting the necessary information related to Karatbars on this website.
If you have any questions, let me know.
P.S. By the way, today is June 22, exactly 75 years ago Nazi Germany attacked the Soviet Union… the early morning of June 22 in 1941.
I didn’t know that there is actually a difference between paper money and currency! I’m glad that I now know that distinction.
It is a little scary to think that so far, all fiat currencies have gone through devaluations and collapsed. It’s probably to the government’s advantage to devalue it’s currency so that they can pay back their loans with “cheaper money.” And the normal citizen end up footing the bill for it.
How long has the United States Dollar been a fiat currency? It seems like that average life expectancy might be just around the corner… 🙁
Greetings Nick! So sorry for the late response.
Precisely! Fiat currency gives central bankers a chance to create money virtually out of nothing (electronically or actually printing it) to fight recession and pay off government debts (for the wellbeing of humanity of course 🙂 ), at the same time creating inflation, that is, a drop down in the value of currency, your savings, and thus hours of your life! Here, you can read more about how central bankers are playing this money game and how it results in you donating hours of your life. I laid it out in easy-to-understand details.
United States completely detached its dollar from gold in 1971 making the fiat US dollar to be 46 years old now.