Fiat money
Government-issued currency not backed by a commodity.
Wikipedia / Wikimedia Commons
Fiat money is a currency issued by a government, typically through its central bank, and declared legal tender by law. Unlike commodity money (like gold or silver coins) or representative money (which can be exchanged for a commodity), fiat money is not backed by any physical asset or precious metal. Its value does not come from any intrinsic worth or practical use; instead, it holds value because the people using it collectively agree on that value and trust that merchants and others will accept it for payments. Since the Jamaica Accords of 1976 ended the Bretton Woods system, every major government currency worldwide has been fiat money.
The first government-issued fiat banknotes appeared in China during the 13th century. Fiat money became dominant in the 20th century, and after President Richard Nixon ended the U.S. dollar’s convertibility to gold in 1971, a global system of national fiat currencies took hold. Fiat money can be defined in several ways: as money declared legal tender by a government, institution, or person; as state-issued currency that is neither convertible to anything else nor fixed to an objective standard; as money used solely because of a government decree; or as an otherwise valueless object that serves as a medium of exchange (also called fiduciary money). The term “fiat” comes from Latin, meaning “let it be done,” referring to an order or decree.
In monetary economics, fiat money is seen as an intrinsically valueless object or record that is widely accepted for payments. Its value therefore exceeds the worth of its material content, such as paper or metal. One economic justification comes from micro-founded models, like that of Lagos and Wright, where agents are happier with more money even though it has no intrinsic worth; its value is created internally by the community, enabling trades that would otherwise be impossible. Game theory also offers an explanation, as in the Kiyotaki and Wright model, where an object with no intrinsic value can become valuable in trade within certain Nash equilibria.
Objections to fiat money date back to at least the 1700s. In 1787, George Washington wrote that paper money “ruin commerce—oppress the honest, and open a door to every species of fraud and injustice.” Karl Marx, in his *Grundrisse* (1857–58), considered the shift from commodity-backed currency to fiat money. He imagined a scenario wh
- type
- Currency system
- first_use
- 13th century in China
- modern_global_adoption
- Since 1971 (Nixon's suspension of dollar convertibility to gold)
- key_characteristic
- No backing by precious metal or commodity
- etymology
- Latin for 'let it be done'
- alternative_to
- Commodity money and representative money
Lore & Background
Fiat money was first used as government-issued banknotes during the 13th century in China. The Song dynasty issued paper money called jiaozi about the 10th century CE, though conversion to gold, silver, or silk was never allowed in practice. The succeeding Yuan dynasty, under Kublai Khan, issued paper money known as Jiaochao as the predominant circulating medium. Marco Polo described this fiat money in his book, noting that it was accepted throughout the Khan's dominions for all sales and purchases as if it were pure gold or silver.
Reader's Guide
Fiat money's significance lies in its role as the foundation of modern global monetary systems. Since the end of the Bretton Woods system in 1976, all major government currencies are fiat money, meaning they are not convertible to gold or any other commodity. This system allows central banks flexibility in managing money supply, but it also generates debate among economists: Austrian, monetarist, neoclassical, and New Keynesian economists argue that increasing fiat money supply causes inflation, while Keynesian, Post-Keynesian, and modern monetary theory economists argue that such increases are insufficient to cause inflation. Objections to fiat money date back to at least the 1700s, with George Washington writing in 1787 that paper money 'ruin commerce—oppress the honest, and open a door to every species of fraud and injustice.' Karl Marx, in the Grundrisse, considered that an unlimited increase of bank drafts alongside limited national wealth would lead to inflation and falling interest rates. Fiat money's value is explained in economic models as being created internally by the community, making otherwise infeasible trades possible.
Did You Know?
- Fiat money was first used as government-issued banknotes during the 13th century in China.
- The term 'fiat' derives from Latin for 'let it be done', used in the sense of an order, decree or resolution.
- In 1661, Johan Palmstruch issued the first regular paper money in the West, by royal charter from the Kingdom of Sweden.
- George Washington wrote in 1787 that paper money 'ruin commerce—oppress the honest, and open a door to every species of fraud and injustice.'
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