Fiat money is a currency that has no intrinsic value but is made legal tender through an order by the government or through legislation. Forex is actually cash that has been deemed as legal by a particular government; however, like the gold standard, it is not anchored by an actual product. However, its value is in the faith that the general public and governments have for it. Fiat money gets its name from the Latin word fiat, which means let it be done, since the value of this money is created by an order.
Understanding Fiat Money
Fiat money is quite different from commodity money which is money whose face value is the value of the material in which it is made. For instance, gold coins were an accepted as a commodity money since their value relied on the cost of the gold in producing the coins. FIAT money on the other hand is useful only because a government in particular supports the value and because the parties involved in any exchange agree to attach such value to it.
Again, unlike commodity money which can be exchanged for a given quantity of some good in the economy, fiat money is non-convertible. It’s stability depends on economic factors, political decisions and the people’s confidence in a currency. This sort of money is more prevalent today than any other around the globe hence making it the most preferred.
How Fiat Money Works
The fiat money works on the assumption of confidence. The government is the issuer of money and ensures that the money will be accepted in the payment of all existing debts- public and private. Fiat money is accepted in exchange for commodities and services due to the belief that the others also will accept it. It enables it to act as medium of exchange due to the trust placed in the currency.
The supply of the fiat money is often under the control by a country’s central bank and thereby affects inflation and interest rates. Since fiat money is not tied to any specific commodity, there is always an increased policy freedom unto the government and the central bank. They can simply reproduce more of it, or decrease its production to support their set economic objectives. However, in certain cases, this flexibility get distorted and give raise to undesirable phenomena such as hyperinflation or economic instabilities.
Fiat Money in India
The Indian rupee (INR) is the official fake money in India. Similar to other currencies in floating regimes, the value of Indian rupee depends on the government and RBI who control the issuance of the tender. It means that the rupee does not represent a physical metal such as gold but it value is anchored on the reputation of the economy of India.
India departed from the gold standard which acted as storage of value and adopted full fiat money system in twentieth century. The rupee is controlled by the government of India but its circulation and supply are regulated by the RBI, which formulates the inflation, growth rate and balance of payments rate.
Reportedly, fiat money has added more influence to the Indian government in managing its economy. It can sap the value of money, funded big-ticket infrastructure, and respond to a crisis while keeping inflation in check, making an entire civilization prosper. But this also indicates that the value of rupee depends on inflation and that it also carries devaluation risks that are influenced by the domestic and the global economy.
The Pros and Cons of Fiat Money
Advantages:
Flexibility in Monetary Policy: Understanding fiat money is distinguishing an essential aspect of economics and central banking because it offers governments the ability to control and manipulate an economy by managing the supply of fiat money. This can be useful when the economy is bad or in other words when there is a recession.
Efficiency in Trade: It will be noted that fiat money is light in value and can thus be easily transported, and is accepted globally thus making it suitable for the promotion of both global and domestic trade.
Stability in Transactions: This is due to the fact that fiat money is accepted in the course of exchange by law and order which give stability to the medium, whereas, barter has instability since it is based on the coincidence of wants.
Disadvantages:
Risk of Inflation: The main concern of fiat money is inflation. When a government prints too much money, the value of the said money gets devalued, and this results in a high cost of goods and services.
Trust-Dependent: Fiat money has no intrinsic value and is only made to be accepted by law throughout the relevant nation. When the public demeans the use of the money or the political regime that is behind the currency, the prices for the money reduce causing an economic problem.
Potential for Hyperinflation: Leading causes of a failure in fiat money include hyperinflation which has been evidenced in nations such as Zimbabwe or Weimer Germany where for instance the money being used became useless as prices of goods soared way beyond reasonable figures.
The Fiat Currency Matrix
This ‘fiat currency matrix’ represents the relationship that exists between Fiat currencies in the global economy. Foreign exchange cannot be viewed in isolation because all currencies are being bought and sold, appreciated and depreciated in relation to one another in the foreign exchange markets. This matrix of relationships defines how qualified or feeble a currency is relative to others and thereby affects buying-selling, investment, and tour operations across borders.
For example, the exchange rate of rupee to dollar has a certain impact on how much India has to pay to import oil and how suitable are its exports in the global markets. Fiat currencies’ exchange rate suggests that it depends on such factors as inflation, interest rates, balances of payments and politics among others.
Conclusion
Fiat money is undoubtedly essential in the world economy because its existence allows governments to exercise more control over economic development. As expected, it has benefits that are evident and straightforward, like a detailed flexibility and efficiency.
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