If you follow alternative financial media, you\u2019ll often hear dollars derisively referred to as \u201cfiat currency.\u201d What exactly does this term mean and why is it often used as a slur?<\/p>\n\n\n\n
Investopedia defines fiat money as a government-issued currency not backed by a physical commodity such as gold or silver.<\/p>\n\n\n\n
So, what is fiat backed by?<\/p>\n\n\n\n
\u201cThe full faith and credit\u201d of the issuing government.<\/p>\n\n\n\n
In other words \u2013 nothing.<\/p>\n\n\n\n
Fiat money is just paper (or digits in a computer). It only has value because the government says so, and the majority of people accept it at its word. It doesn\u2019t hurt that governments have the power to maintain a monopoly over their currency through legal tender laws, keeping competing currencies at bay.<\/p>\n\n\n\n
All modern government currencies are fiat, including the dollar, the euro, the yen, and the yuan.<\/p>\n\n\n\n
Since fiat money isn\u2019t tethered to a commodity, its value effectively floats. It is based on supply and demand, along with the stability of the issuing government. Most people express the value of fiat money by comparison to other fiat currencies. When you hear about a \u201cstrong dollar\u201d it means the greenback is strong compared to other global currencies.<\/p>\n\n\n\n
So, what\u2019s the problem with fiat?<\/p>\n\n\n\n
It is effectively limitless.<\/p>\n\n\n\n
Governments can create as much fiat money as they want. We often refer to this as \u201cmoney printing,\u201d although today it\u2019s not even that hard. A government or central bank can create new money with a few keyboard strokes.<\/p>\n\n\n\n
As economist Thorsten Polleit put it, fiat money economies are built on lies.<\/p>\n\n\n\n
\u201cFiat currencies are produced by central banks and commercial banks\u2019 credit expansion. In fact, central banks in cahoots with commercial banks increase the outstanding money supply by extending loans to firms, private households, and government entities. It amounts to money creation from thin air or\u2014in a way\u2014counterfeiting money<\/strong>.\u201d<\/p>\n\n\n\n We go to prison for counterfeiting. The government does it as a matter of policy.<\/p>\n\n\n\n But when you really think about it, there is no fundamental difference between me printing off a bunch of bills and calling it \u201cmoney\u201d and the government doing it. If I could get enough people to believe my paper had value, it could be money too.<\/p>\n\n\n\n Sound money such as gold and silver, or currencies backed by a commodity, are limited by the supply of that commodity. You can\u2019t print gold or silver. That means if a country issues a gold-backed currency, the only way it can create more is to acquire more gold. This limits the issuance of new money, minimizing inflation and keeping the value of money relatively constrained and constant.<\/p>\n\n\n\n Think of it this way: when you make more of a thing, the value of the other thing decreases. If you have 100 widgets and make 100 more, the value of each widget will decrease (assuming demand is stable.) The same is true for dollars. When you make more dollars, each individual dollar is worth less and it buys less. Or as Polleit put it, \u201cThe relentless expansion of the quantity of fiat money causes the purchasing power of the money unit to decline over time.\u201d<\/p>\n\n\n\n \u201cWhat is more, increasing the quantity of fiat money creates winners and losers, it is not a win-win game: The early receivers of the new money benefit at the expense of the late receivers. It leads to an unjust and unsocial distribution of income and wealth within society.\u201d<\/p>\n\n\n\n You can see the inflationary tendency in the fiat dollar economy when you compare the expansion of the gold supply to the expansion in the dollar supply.<\/p>\n\n\n\n The above-ground gold stock has expanded by an average of 1.2 percent annually over the last 529 years. Since 1960 the average growth in the gold supply is slightly higher at 1.8 percent, ranging from 1.4 percent to 2.2 percent per year.<\/p>\n\n\n\n Meanwhile, since 1960, money supply growth varied from a low of 1 percent in 1993 to a high of 19.1 percent in 2020. The inconsistency in the growth rates results in frequent and sharp swings in prices. There are either not enough or too many dollars circulating relative to the prevailing level of economic activity. This volatility is part of the boom-bust cycle.<\/p>\n\n\n\n But over the long haul, the value of every fiat currency depreciates over time because governments can\u2019t resist the temptation to create more of it.<\/p>\n\n\n\n Consider the dollar. The greenback has lost more than 85 percent of its value since President Richard Nixon severed the dollar from the last vestiges of the gold standard. The purchasing power of a 1971 dollar is equal to about 13 cents today.<\/p>\n\n\n\n Meanwhile, the dollar value of gold has gone from $35 an ounce to around $2,300 an ounce today. In percentage terms, that\u2019s a 6,471 percent increase.<\/p>\n\n\n\n Fiat money also introduces counterparty risk. In simple terms, it is the possibility that the party on the other side of a transaction might not fulfill its obligation.<\/p>\n\n\n\n Who is the counterpart behind fiat money?<\/p>\n\n\n\n The government.<\/p>\n\n\n\n If you trust the government to maintain a sound, stable currency, I guess there\u2019s no problem. But if you don\u2019t?<\/p>\n\n\n\n When you boil it all down, fiat money is smoke and mirrors. You want real money. And gold and silver have been filling that role for thousands of years.<\/p>\n","protected":false},"excerpt":{"rendered":" If you follow alternative financial media, you\u2019ll often hear dollars derisively referred to as \u201cfiat currency.\u201d What exactly does this term mean and why is it often used as a slur? Investopedia defines fiat money as a government-issued currency not backed by a physical commodity such as gold or silver. So, what is fiat backed by? 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