Fiat Money

The Advantages and Disadvantages of Fiat Money

Fiat money is a type of note whose value is declared by the government. It often comes as paper money, coin or electronic form which is common because of today’s easy online and electronic transactions. The word “Fiat” is Latin which means “let it be done”. The term could also be considered as a declaration or decree. With that meaning in mind, the government’s declaration of the paper’s value is the essential part of fiat money. The government has to issue a decree so that it would be recognized as legal tender in every transaction.

Many consider fiat money as false money because in itself the paper money doesn’t have any value. It only gained value because of the government’s declaration. It is even said that the coins could cost more as a metal rather than using it for its declared value. While the world is already accustomed to the fact that paper money means it comes as higher value, these notes would be nothing without official government recognition.

Compared to Honest Money

Fiat money is the direct opposite of honest money. In fiat money, the actual value declared by the government is only based by its country’s economic standing. Fiat money doesn’t have any supporting or real resources that could prove that it actually represents the money the government has. Honest money, on the other hand, is backed by real resources such as silver and gold. The government or its arm in charge of printing notes is only limited to the actual wealth of the government. Honest money is practically a paper version of bartering since it is an actual representation. Fiat money is just there and continues to be of value simply because of government declaration.

The US Experience on Fiat and Honest Money

USA and other countries with large economies usually support fiat money. Because of the power of their economy, they can easily handle printed notes. Although their currency is not backed by actual resources, their declaration and position in world economics have made these countries easily deal with potential problems of Fiat money.

One of the most drastic turnaround from honest money to fiat money is the event called the “Nixon Shock.” In 1971, President Nixon pulled out from the convertibility of printed money to legal tender. Before 1971, the government only issues notes based on their gold reserve. Many countries bought their gold reserves that it became a problem for USA since their gold reserves are dwindling. To prevent recession and other economic problems from happening, President Nixon pulled out its support for honest money and turned to fiat money. This decision is quite controversial since no consultation to the congress and IMF was made.

The reason for Nixon’s pull out from dollar exchange for gold standard is relatively simple. The gold standard was setup in 1944 and implemented in 1946 through the Bretton Woods Agreement. During that time, the US government is leading the reconstruction efforts after WWII and they have pledged to almost every country that requires assistance. They also allowed countries to improve their economy by purchasing bullions from the US at $35 per ounce. With this rate, US experienced rapid acquisition of gold which resulted to local economic problems. Nixon’s decision actually helped a lot in preventing gold and silver from being traded to anyone.

Advantages of Fiat Money

Fiat money has been used by almost any country with a stable economy because if its practical use. Without the paper note declared by the government, citizens will continue to trade with gold and/or silver. Through Fiat money, the government can easily control the economy simply because they can print notes or paper money without checking their resources. Of course, printing paper money is a delicate process for security reasons and they can’t just print as much as they can because it will cause inflation.

Disadvantages of Fiat Money

While the advantages of Fiat Money include the country’s ability to maintain economic viability, it does come with disadvantages. The main disadvantage is that the notes are made with the government declaration. When the government that declared these notes valid no longer exists, the paper money has no value or use. This is the reason why large countries can use Fiat money because they can handle factors that can easily destroy economies. Another disadvantage is that it covers the country’s real economic situation. Printing paper money could be beneficial even though it doesn’t have the financial backing but this cloaks the actual reserve or resources. When a country uses honest money, they are assured that their current standing is an actual reflection of the country’s economy.

Large countries around the world have relied on the capability of Fiat money. But this is a dangerous proposition even though countries are unlikely to be destroyed by its own economic decisions. Money printed on paper and declared legal by the government has no intrinsic value and will only last while the government still exists.

Fiat Money Quotes (4)

From the beginning of recorded history, humanity has used all sorts of things as money. Salt, shells, beats, livestock - all had their day. But over time metals, particularly gold and silver, have emerged as the most widely used forms of money. This is not an accident. Precious metals have all the qualities that make money valuable and useful: scarcity, desirability, uniformity, durability, and malleability.

Even if people didn't want the metal as money, it still had value based on its other uses and relative scarcity.

In contrast, paper money has value only as long as enough people agree to take it in exchange for goods and services. But that makes its value completely subjective. Since it can be produced at will, and has no intrinsic value itself, the paper can become worthless if enough people lose faith in it.
— Peter Schiff; How an Economy Grows and Why It Crashes

When a currency changes its character from gold-receipt to fiat paper, confidence in its stability and quality is shaken, and demand for it declines.
— Murray Rothbard; What Has Government Done to Our Money?

Historically, every time governments have printed their own money, fiat money, that money eventually reverted to its true value: zero. That's because paper money is a zero-sum game. Will the same happen to the U.S. dollar, the yen, the peso, the pound, and the euro? Will history repeat itself?

Now, I can hear many proud, red-blooded Americans saying, "This will not happen in America. Our money will never go to zero." Unfortunately it already has—many times. During the Revolutionary War, the American government printed a currency known as the "continental" After the government printed too many continentals, our money became a joke, giving birth to the phrase, "Not worth a continental." The same thing happened to the Confederate dollar. When I need a reminder of money going to zero, all I have to do is think about the woman fruit vendor in Vietnam and her aversion to the piaster. That was not that long ago. It's not ancient history.

Today, the entire world is running on Monopoly money. But what if the party is over? Will bailouts save us? Ironically, every time there is a bailout our national debt grows bigger, we pay more in taxes, the rich get richer, and our money's value edges closer to zero. Every time our governments print more money, our money becomes less valuable. We work harder for less and less, and our savings are worth less and less.

I am not saying today's Monopoly money will go to zero. I'm not saying it won't either. Yet, if history does repeat itself, and if the U.S. dollar goes to zero, the worldwide chaos will be cataclysmic. It will be the biggest wealth transfer in world history. The rich will get richer. And the poor will most definitely get poorer. The middle class will be wiped out.
— Robert Kiyosaki; Rich Dad's Conspiracy of The Rich

Fiat money is simply money backed by government's good faith and credit. If anyone messes with the government's and central bank's monopoly on money, the government has the power to put that group or person in jail for fraud and counterfeiting. Fiat money means all bills payable to the government, such as taxes, must be paid in that nation's currency. You cannot pay your taxes with chickens.
— Robert Kiyosaki; Rich Dad's Conspiracy of The Rich