Fiat currency, also known as fiat money, is a type of currency that is declared by a government to be legal tender and is accepted as a medium of exchange within a specific country or region.
Unlike commodity money, which has intrinsic value because it is backed by gold or silver coin, fiat currency has no inherent value and is not backed by a physical commodity.
Instead, its value is established and maintained by government decree and the trust and confidence of the people who use it.
Modern currencies, including the US Dollar, European Euro and the British Pound, are all examples of fiat currencies.
The United States began transitioning away from the gold-standard during the first half of the 20th century. During the Great Depression, the government took the extreme step of confiscating all of the gold coins that were circulating throughout the economy and made it illegal for private citizens to own gold.
Many of the gold coins were melted into large format gold bars and were moved to the Gold Depository at Fort Knox, where they remain sealed away to this day.
In the case of the dollar, its value is established and maintained through the authority and credibility of the Federal Reserve. It’s essentially a social agreement that people will accept the currency in exchange for goods and services.
Commodity Backed Money
Fiat currency has no inherent value as it is not backed by a physical commodity. Commodity backed money, which is backed by gold, silver or other commodities, has value due to its intrinsic properties.
The Treasury and Federal Reserve have the authority to control the supply of dollars. They can print more money or remove it from circulation, which can influence factors like inflation and deflation.
The regulators at the Fed and Treasury Department have a few monetary policy tools at their disposal to manage the economy. This includes adjusting interest rates, implementing quantitative easing, and regulating the money supply to influence economic conditions.
One of the major concerns with fiat money is the potential for inflation. Since fiat money is not backed by gold or silver, governments and central banks have the authority to print money at will. If the money supply increases faster than the growth of goods and services in the economy, it will lead to inflation, eroding the purchasing power of money and causing prices to rise.
Unlike commodity money like gold or silver, which have intrinsic value, fiat money has no inherent value. Its value is solely based on the trust and confidence that people have in the issuing government. If that trust wanes, the value of fiat currency can be at risk and individuals and everyday workers will continue to see the purchasing power of the dollar diminish over the years. It can impact the ability to save for the future and plan for retirement.
While physical coins and banknotes are common forms of fiat currency, many of today’s transactions are conducted digitally using electronic forms of money, such as online banking, credit cards, and digital wallets.
Fiat Money CBDC
The Federal Reserve and other central banks are pushing for the adoption of a Central Bank Digital Currency (CBDC), which will allow the government to control how you spend your money, and what you will be allowed to purchase.
While this can be used to manage the economy, it also means that economic decisions are concentrated in the hands of a few, which will lead to potential abuse or mismanagement.
CBDC transactions can be easily tracked and monitored by the central bank and government authorities, raising significant concerns about individuals’ financial privacy and the potential for government surveillance.
The digital nature of CBDCs also makes them vulnerable to cyberattacks and hacking attempts. A successful breach could lead to the theft of funds or disruption of the financial system.
The introduction of CBDCs will continue to disrupt traditional banking and payment systems, affecting financial institutions and fintech companies.
CBDC allows central banks to have more direct control over monetary policy and money supply. Fiat currency is influenced by central bank policy but also impacted by commercial banks and economic factors.
The introduction of CBDC requires additional technological infrastructure and regulatory frameworks for digital payments and security. Earlier this year, the Federal Reserve introduced the FedNow payment gateway system, requiring commercial banks to adopt this new payment system is part of the long-term launch plan.