What is Fiat Currency?14/10/2010 23:23
Fiat money is the opposite of honest money. Fiat money is money that is declared to have value even if it does not. Honest money has value regardless of what people say. Gold and silver are often referred to as honest money and since they have been dug out of the ground at considerable expense, they do have value regardless. People will pay variable sums for them.
Fiat money is also known as paper money, or electronic money. Since there is nothing behind paper money but the obligation of a state to redeem it in more paper or electronic money, fiat money's ultimate worth is questionable at best. In fact, there is a history of states walking away from the face value of the fiat money that has been printed (created). But if one has it in one's possession, it is impossible to walk away from the value of gold and silver – and contrary to fiat money, they have an inherent quality.
Mainly an outgrowth of central banking, in the modern age, fiat money probably would not be attractive without state support. That's because fiat money, unlike fractional reserve money, has no inherent value. Fractional reserve banking, in fact, is a private market phenomenon in which private banks provide paper notes the face value of which adds up to more than the reserves held by the bank. There is a history of successful fractional reserve banking efforts within the private marketplace, however fiat money ALWAYS collapses, as it is impossible to issue a substance of value year after year and generation after generation that HAS no value.
In the United States, the world's largest and most dominant economy, the greenback became a fiat currency when President Richard Nixon broke the final link between gold and the dollar in 1971. He did this because the French were apparently threatening to redeem their dollars in gold – and either the US central bank and/or Treasury did not have enough gold to redeem French greenbacks or chose not to.
In any event, Nixon severed the dollar's relationship to gold and ever since then the world has embarked on a "bold experiment" in which the global, anchor currency has no specific relationship to an underlying asset. Predictably, this has meant that the United States has continually created more and more fiat dollars, thus inflating the overall stock of dollars and making them worth less and less.
China, one of the world's most ancient civilizations, is said to have had no less than eight separate interregnums of fiat currency – each collapsing and then being replaced by another. In the 1800s, fiat money was even banned by the Chinese. Today, however, the Chinese government is once again a user of fiat money along with the rest of the world. Fiat money has never been so prevalent perhaps as in the modern age. But that doesn't make it any healthier or less prone to failure. Those who ignore history are doomed to repeat it.