Fiat money - in other words a currency whose value is anchored by the government’s word and not a commodity - is not much older than crypto. Really? Read on and find out.
Nowadays, there are two main kinds of money: fiat currency and crypto. You might think that fiat, like the U.S. dollar is today, has been around forever and that crypto is new, but the current implementation of government-backed money is only about 50 years old, and non-governmental currencies, sometimes called script, have been around for centuries. Today, we’ll focus mostly on fiat currency with a lot of comparisons to the others.
Fiat, commodity, and representative money
Fiat is one of three types of money. It keeps its value because users have faith in its value being maintained by the government that issued it. This does not mean that the currency is backed by a precious metal directly – that would be representative money. Older U.S. paper money, such as silver certificates, would be a good example of representative money, while coins with precious metals content, such as silver dollars, would be commodity money.
It is rare these days, but in the U.S., paper money that used to be representative could be found mixed with fiat money in circulation. These silver certificates used to be exchangeable for the actual metal on demand. In the 1960s, rising demand for silver brought on a change by the treasury, and the silver certificates could only be exchanged for fiat paper money. Demand for silver had grown to the point that silver certificates were no longer a sustainable holder of value. Two years later, the Treasury Department suspended the dollar’s fixed exchange rate, or peg, to gold, and let the currency float freely based on supply and demand. The paper money retained face value, but no more, at least as a means of exchange.
What is fiat money actually worth?
Conspiracy theory followers might claim that by leaving the gold standard, the U.S. broke away from concrete ties between commodities and money; all fiat now holds value only by agreement. There is a problem with this idea: how much is the commodity worth, and isn’t there an agreement in that case as well? The consensus created in 1944 by the Bretton Woods agreement gave little room for exchange rates to adjust to changes in economies or supply and demand.
Unplanned changes in supply could wreak havoc on a commodity pegged economy. In Candide, Voltaire famously creates a society where gold is so plentiful that nuggets lay around on the ground. In today’s world, people who dream big can see mining an asteroid with enough gold to distort any pegged currency. At some level, money becomes a matter of trust in the issuer.
