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* Fiat currency definition
FIAT CURRENCY DEFINITION
WHAT IS A FIAT CURRENCY?
A fiat currency is a national currency that is not pegged to the price of a
commodity such as gold or silver. The value of fiat money is largely based on
the public’s faith in the currency’s issuer, which is normally that country’s
government or central bank.
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FIAT MONEY VS COMMODITY MONEY
Fiat currency, also known as fiat money, is the opposite of commodity money. The
difference between fiat money and commodity money relates to their intrinsic
value. Historically, commodity money has an intrinsic value that is derived from
the materials it is made of, such as gold and silver coins. Fiat money by
contrast, has no intrinsic value – it is essentially a promise from a government
or central bank that the currency is capable of being exchanged for its value in
goods.
EXAMPLES OF A FIAT CURRENCY
Well-known examples of fiat currencies include the pound sterling, the euro and
the US dollar. In fact, very few world currencies are true commodity currencies
and most are, in one way or another, a form of fiat money.
PROS AND CONS OF A FIAT CURRENCY
PROS OF A FIAT CURRENCY
Since fiat money is not a scarce or fixed resource – like gold – a country’s
central bank has greater control over its supply and value. This means that
governments can manage the credit supply, liquidity and interest rates more
reliably.
Unlike commodity currencies, which could be affected by the discovery of a new
gold mine, the supply of fiat currencies is regulated and controlled by the
respective currency’s government. There is less risk of an unexpected
devaluation caused by the supply of fiat currencies, as any increase in supply
is a pre-empted decision made by a fiat currency’s government.
CONS OF A FIAT CURRENCY
Since it is not tied to a tangible asset, the value of fiat money is dependent
on responsible fiscal policy and regulation by the government. Irresponsible
monetary policy can lead to inflation and even hyperinflation of a fiat
currency.
Adding to this, there is greater opportunity for bubbles with fiat currency – an
economic cycle in which there is a rapid increase in price before an equally
rapid decline in price.
The increased prevalence of bubbles is because fiat currencies have a virtually
unlimited supply, which means that quantitative easing is an option for
governments. While possibly providing stimulus to an economy, quantitative
easing can also cause greater inflation rates. This could impact anything from
housing prices to national debt levels, which in turn could impact the financial
markets.
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