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What is a Fiat Money?

Earlier this month, Utah legislators passed a bill that would make gold and silver coins minted by the government legal tender in the state. Right now, even though the government puts out coins like the gold buffalo, it is considered an asset. It only works at face value — never mind how many ounces of gold or silver are involved. You can’t go into a shop and plunk down a silver eagle coin and have it actually work to buy you some groceries at what you might consider a “fair” exchange considering the prices of precious metals on the commodities market. In Utah, though, that would change. Shops could accept these coins as legal tender, at values accepted by collectors, taking the money beyond face value.

In addition to the idea of allowing gold and silver coins minted in the U.S. (no foreign gold or silver coins are eligible for this treatment) to be used at something more than face value, Utah is forming a commission to study whether or not the state would like to shift to a monetary system based on metals. Utah lawmakers are deeply suspicious of fiat money, which is basically what our entire global economic system is based on.

But what is fiat money?

An Overview of Fiat Money

Fiat is Latin, basically meaning, “let it be done.” Fiat money works because the government says it works, and everyone else agrees. There is no commodity backing it up. You probably remember terms like “gold standard” and “commodity backed currency.” They are being bandied about again in some circles as politicians, economists, investors and others try to figure out what can be done to fix the economy. The idea is that basing money on something solid and tangible will solve our problems.

Fiat money, though, has a long history. The first recorded example was in ancient China. Of course, the paper money issued was originally based on gold, silver and silk. However, as paper bills continued to circulate, rather than being turned in at the end of a set period of time, inflation set in and it became impractical to try backing everything up with a commodity. This practice continued through the Yuan Dynasty until the Ming Dynasty put an end to it in an effort to slow economic expansion.

The American Colonies also issued fiat money. However, during the 1800s, a lot of money was based on silver and gold. A true gold standard wasn’t made U.S. law until 1900. In 1933 gold was outlawed for private ownership beyond jewelry, and in 1946 the Bretton Woods system set up currency exchange between countries based on a system in which gold could be sold to the U.S. for $35/ounce. In 1971, even that was dissolved and now the global economy exchanges currencies based on perception of value. (There are arguments, too, that gold itself is another fiat currency.)

Information as Money: Fiat to the Next Level

Now, of course, our monetary system goes beyond bits of paper said to have value. In fact, with direct deposit, credit and debit cards and PayPal, few us even need to touch paper bills, much less gold or silver coins. Money is largely digital. We all agree that we have a certain amount of “money” in the bank, and if the information is there to “back” you up, you can exchange it for goods or services. In fact, we’re to the point where the entire global economy runs on the idea of money. There isn’t enough paper currency in circulation to “back” the information money in circulation.

So the next question, of course, is: How is it practical to switch back to a gold standard? If there isn’t even enough paper money to back what’s going on, there certainly isn’t enough gold to back it. Right or wrong, we’re in deep with fiat currency. And as long as everyone agrees to keep exchanging services and goods based on bits of information, the system will work. Of course, if people lose faith in the idea of money, it all comes crashing down.

What do you think about fiat money? If you favor some sort of commodity standard, how would you implement it? Could you do so without destroying the economy and reducing everyone to poverty?
This post was included in the Best of Money Carnival

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