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What is a fiat currency?
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Jason can usually be found there, cutting through the noise and trying to get to the heart of the story. All others pay cash. For that reason, many countries have, over the past century, shifted to a fiat currency. But what exactly is fiat currency, and what makes it the best alternative?
Let's take a closer look. Image source: Getty Images.
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Underpinning the value of money Fiat currency is legal tender whose value is backed by the government that issued it. The U.
This approach differs from money whose value is underpinned by some physical good such as gold or silver, called commodity money. The United States, for example, used a gold standard for most of the late 19th and early 20th century.
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- Fiat money is government-issued currency that is not backed by a physical commodity, such as gold or silver, but rather by the government that issued it.
- Commodity money vs. Fiat money (video) | Khan Academy
A person could exchange U. A fiat currency's value is underpinned by the strength of the government that issues it, not its worth in gold or silver.
Why a fiat currency is better economic policy Here's a look at U. The most important aspect of a currency is the relative stability of its value. And while there are certainly more aspects to inflation than just the currency standard, it's a major factor in monetary policy and a government's ability to control the money supply.
With the exception of the late s' and early s' oil crisis and recession, inflation has become much less volatile, and deflation hasn't been an issue. A key reason is U. Since the Federal Reserve has more flexibility to control supply and demand of currency, it is more able to limit the impact of major economic shocks, such as the financial crisis of Many economists acknowledge that the government's ability to control the supply of currency played a major role in keeping the crisis -- easily the worst in 80 years -- from causing even greater harm to the American and global economy.
What gold advocates ignore Those who advocate for a gold or similar standard often use the argument that fiat currencies aren't really "worth" anything, since there isn't anything tangible that underpins its value. That's really not a very accurate description of a fiat currency, versus a gold standard.
During the 11th century, the government established a monopoly on its issuance, and about the end of the 12th century, convertibility was suspended. Although the notes were valued at a certain exchange rate for gold, silver, or silk, conversion was never allowed in practice.
What does that chart tell us? In times of uncertainty, people hoard gold.
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- Simply put, fiat currency is legal tender that derives its value from its issuing government rather than a physical good or commodity.
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You can see it in the early '80s oil crisis and recession and the most recent financial crisis, when gold prices soared, only to fall sharply once the overall economic environment improved. This situation is what is fiat what what is fiat Franklin D. Roosevelt to sever the convertibility of U.
Under the gold standard especially when currency could be converted to goldhoarding gold had a direct impact on monetary flow, hurting commerce and exacerbating recessions.
Banking and the expansion of the money supply Video transcript - [Voiceover] Let's take a look at a United States one dollar bill. What is it that gives this thing value? You can give it to people and get back, ya know food that you can eat, or things that you can use, and things of hard value. But what is it about this little piece of paper that makes it valuable?
By severing the link what is fiat gold reserves and currency, the Federal Reserve is better able to combat major economic shocks to the economy. Think gold is a great investment?
Fiat currency definition What is a fiat currency? A fiat currency is a national currency that is not pegged to the price of a commodity such as gold or silver. Learn how forex trading works Find out more about forex trading, including what currency pairs are. Learn more Fiat money vs commodity money Fiat currency, also known as fiat money, is the opposite of commodity money.
Stability is key It's fair to argue that the Federal Reserve's efforts to limit the impact of economic crisis could have unforeseen long-term effects, based on the additional money that has been put in circulation, versus a gold or silver standard that limits how much money circulates. The problem gets back to times of major economic crisis: When governments need tools to stop or reduce the harm, a commodity standard has historically had the opposite effect as people hoard it. By severing the tie between a commodity that people tend to hoard in times of crisis and the value and supply of money, a fiat currency is a better alternative, but only so long as those pulling the levers of monetary supply keep the balance between supply and demand stable.
Here's the bottom line: Currency is a tool of trade. People tend to hoard gold and silver when things are uncertain, and that's harmful when it limits currency flows on a large scale. Removing the relationship between a currency and commodity doesn't create "worthless money.
And that makes a fiat currency far better than a gold standard. Motley Fool Returns.