Wednesday, August 16, 2017

What is Fiat Money?

The term "Fiat Money" literally means any money declared by a government to be legal tender. It is derived from the Latin word fiat, meaning "let it be done" To put it plainly, it is"Unbacked" currency, which means - cannot be converted into coin or specie ( Bullion coins, commodity metals, hard money) of equal value.
Fiat money is created from virtually from nothing because it is not backed by any real value, whose value is determined by legal means. That's is all.

What is the implication?
North  Korean Won
Take for example in 2009 November when the North Korean Government decided to devalue their won by 100 to 1 overnight, declaring the old currency as void and only the new currency won to be only of legal tender. The old denomination of 1,000 won is replaced by the new 10 won. If that was bad news, the North Koreans were given only seven days to exchange a maximum of 100,000. As part of the process, the old notes ceased to be legal tender on November 30, 2009

Overnight, the wealth of many North Koreans were reduced to nothing by the Government. All the years of building up their wealth became virtually nothing in just one night. Their old won, the paper money which was their source of confidence became worthless.
Is this what it means by "legal tender"
Basically, Fiat money is is declared by a government act (fiat) to be acceptable and officially recognized payment for all debts, both public and private. So if a Government decides to change the "legal tender" status, then "let it be done"
In a fiat money system, money is not backed by a physical commodity (i.e.: gold). Instead, the only thing that gives the money value is its relative scarcity and the faith placed in it by the people that use it. A good primer on the history of fiat money in the US can be found in a video provided by the website.

In a fiat monetary system, there is no restrain on the amount of money that can be created. This allows unlimited credit creation. Initially, a rapid growth in the availability of credit is often mistaken for economic growth, as spending and business profits grow and frequently there is a rapid growth in equity prices. In the long run, however, the economy tends to suffer much more by the following contraction than it gained from the expansion in credit. This expansion in credit can be seen in the Debt/GDP ratio. We track the bubbles created by this expansion of debt at the inflation / deflation page.

In most cases, a fiat monetary system comes into existence as a result of excessive public debt. When the government is unable to repay all its debt in gold or silver, the temptation to remove physical backing rather than to default becomes irresistible. This was the case in 18th century France during the Law scheme, as well as in the 70s in the US, when Nixon removed the last link between the dollar and gold which is still in effect today.

Hyper-inflation is the terminal stage of any fiat currency. In hyper-inflation, money looses most of its value practically overnight. Hyper-inflation is often the result of increasing regular inflation to the point where all confidence in money is lost. In a fiat monetary system, the value of money is based on confidence, and once that confidence is gone, money irreversibly becomes worthless, regardless of its scarcity. Gold has replaced every fiat currency for the past 3000 years.

More info can be found here