Fiat vs Representative Money: What’s the Difference?

Today there are a multitude of countries dealing with their own inflation problems as a result of government overreach. Venezuela is sitting at a 2000% inflation rate, while Lebanon hovers around 200%. Argentina’s currency has lost half of its value and Turkey’s has lost one-third. Economic policy enacted by countries with the reserve currency like the United States or European Union ultimately trickles down to these smaller nations.

Alternative to representative/commodity money

In fact, the petro isn’t backed by any physical asset, making it another example of a digital fiat currency. While Venezuela still uses the bolívar, the petro now stands as another form of legal tender that residents can use within the country. dividend per share formula But El Salvador isn’t the only country with a vested interest in digital currency. Amid a wave of hyperinflation beginning in 2016, the Venezuelan government was working to find an alternative to its national currency, the bolívar.

1. Under the post-World War II Bretton Woods system, the U.S. dollar served as an international reserve currency, backed by gold at a fixed value of $35 an ounce.
2. Currently, most nations use paper-based fiat currencies that only serve as a mode of payment.
3. Fiat money is a currency issued by a government with value derived from trust and authority, not tied to any physical commodity.
4. At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content.
5. In some cases, these smaller less developed countries don’t even issue their own currency.

Pros and cons of fiat money

In recent years, you may have heard the term “fiat” intermingled with the crypto realm. A fiat currency must be issued by a government, while most cryptocurrencies are created by non-governmental individuals or groups. The term “fiat” has been around for over 150 years, though fiat money has been around since the Song Dynasty of 11th-century China when notes began to represent financial value. It wasn’t until centuries later that this form of currency began to become central to national economies.

Money without borders

The U.S. went off the gold standard for domestic transactions in the 1930s and ended international conversions in 1971. It’s unclear whether hyperinflation is caused by the “runaway printing” of money. It’s occurred throughout history, even when money was based on precious metals. All contemporary hyperinflation has begun with a fundamental breakdown in the real production economy and/or political instability in the country. The mortgage crisis of 2007 and subsequent financial meltdown tempered the belief that central banks could necessarily prevent depressions or serious recessions by regulating the money supply. The country’s currency was backed by gold and in some cases silver earlier in U.S. history.

Its value is established through the nation’s economic stability and the government’s reliability. Because it is not based on any fixed or scarce commodities like precious metals, central banks also have much greater control over the supply of money in an economy. Fiat money, in a broad sense, all kinds of money that are made legal tender by a government decree or fiat. The term is, however, usually reserved for legal-tender paper money or coins that have face values far exceeding their commodity values and are not redeemable in gold or silver. Fiat money affects the economy by permitting governments and other regulatory bodies to implement monetary policies that influence interest rates, inflation, and overall economic stability.

The Bank for International Settlements published a detailed review of payment system developments in the Group of Ten (G10) countries in 1985, in the first of a series that has become known as “red books”. Fiat money can also be useful for exchanging currency when you’re going on vacation, traveling or sending money around the world. International money transfer services allow people all over the world to take one form of fiat money and send it in the form of a different type of fiat currency for a small fee.

Though some fiat currencies were once backed by commodities, they are now only backed by the legislative power of the government issuing them. And there you have an example of the first advantage of fiat currency — being able to manage the money supply to make sure there’s enough to prevent economy-crashing deflation. If the U.S. and other nations had remained on a gold standard, the world’s supply of money would be limited to the available gold.

In this case, a government decrees the value of the currency, even though it isn’t representative of another asset or financial instrument such as gold or a check. The major appeal of representative money was that it was not influenced https://www.1investing.in/ by inflation. Governments were only able to print money up to the value of the gold they held in their vaults. The purchasing power of the U.S. dollar has declined signifcantly since the Federal Reserve was created in 1913.

This is not determined by the worth of the material that is used to produce it, and it is not backed by a commodity of equal value. It has the value that the government says it has, whether that is a nickel or $100. As such, it retains its value as long as the government and its economy remain stable. Most coin and paper currencies that are used throughout the world are fiat money.

So, it’s nothing short of crucial within the economy (or economies) that legalized it, but its value fluctuates wildly depending on the issuing country and where it’s being spent. Therefore, most fiat currencies are subjective, and their value depends on where you are. While it was initially thought that the petro was backed by oil, this didn’t turn out to be the case.

The future could hold more scenarios where the two types of currency become even more deeply intertwined. Representative money is a portable currency that is backed by a physical commodity such as a bank deposit. Various forms of representative money are still in place, including checks and credit cards. Hyperinflation—extremely fast and out-of-control price increases—caused the currency to lose its value. The government began printing banknotes with higher values to keep up with inflation.

A country that followed the gold standard set a fixed price for gold, buying and selling it at that price. That fixed price was used to determine the value of the currency. So if Britain set the price of gold at £500 an ounce, the value of the dollar would be 1/500th of an ounce of gold.