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. 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.
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. 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.
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Irresponsible monetary policy can lead to inflation and even hyperinflation of a fiat currency. Adding to this, there is greater opportunity for bubbles with fiat currency — an economic cycle in which there is a rapid increase in price before an equally rapid decline in price.
The increased prevalence of bubbles is because fiat currencies have a virtually unlimited supply, which means that quantitative easing is an option for governments. While possibly providing stimulus to an economy, quantitative easing can also cause greater inflation rates.
This could impact anything from housing prices to national debt levels, which in turn could impact the financial markets. Discover how to trade with IG Academy, using our series of interactive courses, webinars and seminars. Go to IG Academy. Compare features. The risks of loss from investing in CFDs can be substantial and the value of your investments may fluctuate.
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. You should consider whether you understand how this product works, and whether you can afford to take the high risk of losing your money. While fiat money doesn't have intrinsic value —that being through an objective calculation—its value is set by the government that issues the currency.
Most modern currencies around the world are forms of fiat money. Fiat money can be used to buy goods and services since both parties involved in a transaction agree on the currency's value. Representative money, on the other hand, is valued based on the instrument backing it, whether that's a commodity, asset , or another financial instrument such as a check.
A single dollar may, for instance, be worth a specific amount of gold. Most currencies are no longer backed by commodities. But there are still other forms of representative money, such as checks, money orders , and bank drafts. They can be exchanged for the value listed on the instrument. As mentioned above, the United States severed its ties with the gold standard in , turning its currency into fiat money.
That led all national currencies to be valued against the U. Instead of using gold as the power behind the money, the government is the strength and the reason fiat money has value.
The money has value because the government says it does. In turn, people want to have fiat money. If the government falls on hard times or if people everywhere suddenly did not want a form of currency such as the U. But many governments end up printing too much paper money, which leads to inflation. A dollar is no longer worth a dollar in gold. When this happens, the money becomes fiat money. Fiat money is a form of currency that is backed by a country's government.
As such, this form of money retains its value through the stability of the government and the national economy. Yes, fiat money does have value. Its value is determined by the government, not by the material from which it is produced. The term is derived from the Latin word fiat, which means a determination by authority—in this case, it's the government that decrees the value of the currency and isn't representative of another asset or financial instrument such as gold or a check.
Bitcoins aren't backed by commodities, so they're not necessarily a form of representative currency. They are, though, backed by the faith of investors and—to some degree—governments, so they may be considered a form of fiat currency. Federal Reserve History. Federal Reserve Bank of Dallas. Accessed July 26, Monetary Policy.
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