Fiat currency money is a medium for the exchange of goods and services. However, most people have little understanding of what fiat currency is and how currencies are controlled.
Money is a wide term that refers to any intangible system of value that makes the exchange of goods and services possible. Currency is defined as a physical form of money such as notes and coins. Currency is simply one, tangible form of money. Gold and silver are another form of tangible money.
In the modern world, every good or service is now measured in terms of a monetary value. It doesn’t really matter what is used for monetary value as long as it is recognized and controlled by a market of exchange. Currencies, stocks, oil, gold, silver, wheat, pork bellies, and other commodities are valued daily on international financial markets. All of these can be used as a form of stored value and traded for other commodities, currency, or used in transactions for any goods or services.
The History of Money and Trade
The history of money, how money is created and distributed is a lengthy topic that begins before the Egyptian Empire.
In the beginning there was no concept of money. There was only trade of goods and services. However, physical trade is an inefficient way of doing business. For example, a duck is traded for 2 chickens or 6 apples. So, one chicken was worth 3 apples. A complex set of exchange rules would have been developed. Chickens may have become a standard for measuring the rate of exchange with other goods. Every other good could be measured by how many chickens it would buy. Then the value of every other good would be known in terms of chickens. However, chickens are a poor store of money. You cannot store up your chickens for 10 years.
But trade is too simplistic to be useful in an advancing world, so money was created. Every good or service is now measured in terms of a monetary value, for example, a silver coin. Continuing the above example, if a chicken is worth 6 coins, then an apple is worth 2 coins. The chicken merchant can sell chickens for coins. The money can be held as a store of value which can be used to purchase goods and services in the future.
What is Fiat Currency Money?
Initially, money was real money. That is, money was made from precious metals such as gold and silver. There is only a limited amount of gold and silver in the world that made money, itself, a limited commodity. Nobody could create more money than existed unless they mined it from the ground.
Please note the difference between money and currency.
Currency is defined as a physical form of money such as notes and coins. Currency is simply one, tangible form of money.
Money is a wide term that refers to any intangible system of value that makes the exchange of goods and services possible. Deposits held in bank accounts are a digital form of money which comprises the greatest amount of money in the modern economy. If there is a run on a bank, that is all the depositors want to withdraw their money, there may not be enough printed money to pay out all the depositors in cash.
Gold and silver are viewed as real money because it is a store or value that can be readily exchanged for goods and services. Gold and silver can be stored away for as long as you want to store it.
The value of gold and silver cannot be manipulated or controlled by a central bank. A central bank cannot create more gold or silver to devalue the gold or silver price.
Paper notes are created by a central bank. Notes are viewed as currency that need to be supported by a central bank to provide value and a store of wealth. Many people don’t trust governments or central banks and they like to keep their money in gold or silver.
What is Crypto Currency?
Crypto currency is another way of producing a form of money that is in limited supply and is not controlled by any government. The supply of crypto-currency is limited and strictly controlled. People cannot make more crypto easily. In fact, it takes a lot of resource to generate more crypto-currency. However, as crypto-currency is a digital currency it is easy to exchange it for other forms of money or use in transactions for goods and services.
Personally, I don’t like crypto-currency because it is not backed by a government, economic union, or World Bank. If there is a run on crypto-currency who prevents a financial collapse in value? Who steps in, controls, and stabilizes the crypto-currency market? Who provides a guarantee to crypto-currency holders that the value will be maintained in a period of market uncertainty?
How Fiat Currency Money Works?
Money only works if it is limited in supply. Gold and silver coins worked until there wasn’t enough coins in the world for everyone to trade with. Later, coins became currency. The definition of currency is exactly the same as money except money is made from a real, physical material that is in limited supply, like gold.
Anyone can exchange gold and silver for other forms of money or use in transactions for goods and services. However, only banks can guarantee notes and coins as money as it is only pieces of paper or copper coins.
Coins (now currency) were made with other metals such as copper, tin, zinc, etc. Some coins still had a small percentage of gold or silver but gradually the precious metals were taken out of coins. The important thing is that the coins could not be easily replicated. Governments or central banks created coins and paper notes that could not be easily copied or reproduced. You would need very expensive printing equipment and knowledge of secret techniques to create your own money. The currency is limited in supply because the central bank only prints so much currency for distribution in to the economy.
Debt Creation
Banks create digital money by lending money to borrowers. The bank’s accounts show an asset on the balance sheet. The asset was created out of thin air. Not that there is not enough paper money printed to cover the money lent to customers. But there doesn’t have to be printed money or gold to cover debt created by banks.
Low Interest Rates Are Bad Economic Policy
Fiat Currency Money
Central banks in most countries run a fiat currency system. The system has no real, physical backing for the money supply. Before fiat currencies the government or central bank held a store of gold, silver, or other precious metals to backup (or partially backup) the value of all currency issued.
Eventually, there simply wasn’t enough gold and silver in the world to back up all the currency that had been printed. The reserve asset ratio (amount of gold stored in bank vaults) was reduced to such a low level that printed money was no longer backed by gold and silver.
Today, there is not enough gold in the world to back up all the world’s money supply.
Most currencies in circulation (notes and coins) are fiat currencies.
A fiat currency is a currency that is not supported by a reserve of gold and silver held in bank vaults.
Banks don’t need to manage and store the world’s gold and silver supply. Gold and silver could be traded around the world and used in commerce and industry, mainly for jewellery.
Monetary Inflation
Governments and central banks print more money which causes inflation which devalues your income and wealth. Central banks manipulate official interest rates, foreign exchange rates, and the money supply to keep the economy moving along. They don’t care if they devalue your home or other assets.
In modern times, central banks and governments print money or issue government bonds to create credit. There is nothing of value to backup today’s paper or electronic money.
How Does Fiat Currency Money Work?
Currency is backed up by a government’s ability to raise taxes, create new taxes, sell public assets, or create exclusive rights to operate a business (eg mining license, casino license etc.). This is how governments support their currency.
These taxes, public assets or rights help backup the money supply. But are these enough to fully backup our ever-expanding money supply?
No
There is always more currency issued than what is raised in tax or held in value as public assets.
As the world’s population increases, printed money and credit is increased to keep up with the demand for money.
Governments must ensure the rate of increase in money supply never exceeds the rate of economic growth. Otherwise, there could be a loss of confidence leading to an economic collapse.
What Happens if there is a Financial Collapse?
Is the government really going to sell public assets to pay for everything?
Unfortunately, some governments have sold land, airports, hospitals, schools, and casino licences to eliminate their financial and economic problems. But the government is not going to sell the army, navy, NASA, and Alaska to prop up the economy. That’s when there would be a revolution and people take up arms.
You may be thinking that these are silly examples. But remember, how did the USA acquire Alaska? Russia sold it to them! How did the USA acquire California? The Mexicans voted to become a state of USA. The French originally owned most of Louisiana and sold it to the USA to fund the Napoleonic wars. There is only a limited amount of land on the planet. When governments sell large areas of land it indicates how desperate they were to raise funds to finance a war or failing economy.
Printed Money is Fiat Currency Money
Printed money is a commodity that only the government can produce which makes it controlled and in limited supply. There is only so much printed money in circulation. But in today’s world, people are using printed money less and less. Most transactions are electronic and banks create credit when they lend money. There is not even enough printed money to cover all the debt in the world. Money has become numbers stored in computers. The value of money stored in computers is scarce because there is security over the transfer of those numbers between accounts and banks.
The issue with gold (and other precious metals) is that they are not that useful to industry and society. Gold and silver are mostly used in jewellery. Silver is a great conductor and can be used in the electronics industry but is too expensive compared to other metals, like copper. These metals are supply and demand driven like all commodities. Every year more metal is mined, adding to the amount of gold and silver in the world and the metals are consumed into jewellery.
However, people don’t really need gold and silver jewellery. Gold doesn’t do anything for you. In a world financial crash are people really going to still demand gold and silver? Would gold and silver take over from our currency supply. I don’t think so.
The price of gold and silver might collapse along with all other asset classes. If property, stocks, and cash devalue, why wouldn’t gold devalue too?
I believe the most useful asset class is property because people need somewhere to live, work and shop. People don’t really need stocks, cash, gold, or crypto-currency. People need houses, furniture, clothes, food, and water. These are the assets I would invest in for the future.
US Dollar is the Reserve Currency
The US Dollar has become the world’s reserve fiat currency money. It’s the trading currency standard used in most international trade deals. Now many countries are moving away from basing trade transactions in US Dollars. Many countries are trading directly with their own currencies or the Euro Dollar. The US Dollar standard will most likely come to an end in the future and be replaced with a new system.
Conclusion
It is true that most fiat currency money (not backed by anything real and only backed by government guarantees) that have ever existed have lost their value and eventually become completely worthless. However, in reality many of these currencies were replaced with a new currency, for example, pounds replaced with dollars. Other currencies were superseded by the European Union Euro dollar or countries merged or split apart and created new currencies.
Fiat currency money works well as long as governments manage their economy well. As the world’s population increases, printed money and credit must be increased to keep up with the demand for money.
However, governments must ensure the rate of increase in money supply never exceeds the rate of economic growth. Otherwise, there will be inflation and there could be a loss of confidence leading to an economic collapse.
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