Fiat money has no intrinsic value, which is different from commodity money – where value comes from the underlying commodity. For example, gold has uses other than silver and therefore has intrinsic value. However, fiat money has only one use and one use – to act as money. Yes, fiat money has value. Its value is determined by the government, not by the material from which it is made. Nowadays, fiat money is everywhere in almost every country. There is a small exception in the form of Lebanon, which operates a form of the gold standard. Nevertheless, all other nations work with some form of fiat money. Here are a few examples: the Bretton Woods system ended with the so-called Nixon shock. This was a series of economic changes by US President Richard Nixon in 1971, including the unilateral abolition of the direct convertibility of the US dollar into gold.
Since then, a system of national trust funds with variable exchange rates between major currencies has been used worldwide. [26] Commodity money and representative money both require the extraction of a commodity. Whether it`s gold, silver or something else, it takes work to extract it. This alone entails huge and probably unnecessary costs. When people look at their wallet or bank account, they often take the complexity of legal tender for granted. Money falls into a variety of categories that affect its overall value. Understanding these categories can be helpful when investing, exchanging, or transferring money. This guide defines “fiat” currencies, which are the most common type of currency in the world.
A central bank introduces new money into an economy by buying financial assets or lending money to financial institutions. Commercial banks then distribute or reuse this base currency through the creation of credit through fractional reserve banking, thus expanding the overall supply of “broad money” (cash plus demand deposits). [Citation needed] Central banks can produce as much money as they want, and with advances in technology, they don`t even need to print it anymore. This is both an advantage and, if not properly controlled, a disadvantage. However, let`s focus on this as an advantage. The Federal Reserve controls the supply of U.S. dollars and is the official currency of all 50 U.S. states. While the U.S. dollar has been around for centuries, it has only recently become fiat money.
Until 1971, the US dollar could easily be exchanged for gold. President Nixon severed these ties in August 1971, what would become known as the “Nixon Shock.” Although the UK severed its ties with gold, it was still inextricably linked to it by the Bretton Woods Agreements of 1944. Instead of being backed by gold, it was backed by the US dollar, which in turn was backed by gold. The reason for this was that the United States had the largest gold reserves in the world and was on its way to becoming a global superpower. Thus, control of gold was essentially centralized in the United States. Although fiat money is seen as a more stable currency capable of cushioning recessions, the global financial crisis proved otherwise. Although the Federal Reserve controls the money supply, it has not been able to prevent the crisis. Critics of fiat money argue that the limited supply of gold makes it a more stable currency than fiat money, which has an unlimited supply. Since the world operates under fiat money, there must be a logical explanation for why we exchange fiat money, which is essentially worth pieces of paper? Let`s look at some of the reasons for this below: Economists generally believe that high inflation rates and hyperinflation are caused by excessive money supply growth. [33] Currently, most economists prefer a low and stable inflation rate.
[34] Low inflation (as opposed to zero or negative) reduces the severity of economic recessions by allowing the labour market to adapt more quickly to a recession and reduces the risk that a liquidity trap (a reluctance to lend due to low interest rates) will prevent monetary policy from stabilizing the economy. [35] However, money supply growth does not always lead to nominal price increases. Rather, money supply growth could lead to stable prices at a time when they would otherwise decline. Some economists argue that under the conditions of a liquidity trap, large injections of money are like “pushing on a rope.” [36] [37] Representative money is a currency produced by the state and supported by a physical commodity such as precious metals. Other forms of representative money are still present, including financial instruments such as cheques and credit cards. These forms of payment are now used instead of traditional money, with the intention of paying at a later date. Until World War I, most countries were on the gold standard. .
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