Glossary Term
Fiat Money
Government-issued currency that is not backed by a physical commodity.
Detailed Explanation
Fiat money is a government-issued currency that is not backed by a physical commodity, such as gold or silver, but rather by the government that issued it. The value of fiat money is derived entirely from the relationship between supply and demand, and the stability of the issuing government. Most modern paper currencies, including the US Dollar, the Euro, and the Indian Rupee, are fiat currencies.
Real-World Example
Before 1971, the US Dollar was backed by physical gold (The Gold Standard). You could technically exchange a dollar for a specific amount of gold. Today, the dollar is fiat money—it has value simply because the US government declares it as legal tender and people trust it.
Key Takeaways
- •Fiat money has no intrinsic utility or value—it is valuable because of collective trust.
- •Central banks have the power to print unlimited amounts of fiat money, which can lead to hyperinflation if mismanaged.
- •Fiat replaced the Gold Standard to give governments more control over the economy during crises.