Let’s Talk About Money History

Money makes the world go around, right? We don’t want to be dependent on money, but most people around the world can’t live without it. That’s a fact. Before cryptocurrencies occurred, there was only one kind of money that we knew - don’t confuse money with currency. We all had Fiat Money, although we probably didn’t know it was called this. But what is fiat money actually and how does it differ from crypto?

Fiat Money - Definition and history of origin

Definition: Fiat money is a legal payment supply regulated by the country's government and central banks. Today, most countries in the world use a fiat currency system. The strength and value of the currency mostly depend on the economic and political strength of the government behind it.

Before such currency systems existed, people had to engage in barter. That means they had to exchange goods with one another. As you can imagine this was not always practical. For example, a farmer had to swap his harvest for the everyday things he needed. A blacksmith might trade his goods and services for groceries and so on. The more goods there were and the larger the parishes became, the more complicated the barter became. Later people went to mint valuable metals like gold or silver and other limited raw materials. These raw and valuable materials were then used to exchange for the stuff people needed.

The first paper money has its origin in ancient China. It was probably around the 11th century, in the province of Szechuan. Here paper was printed and issued as money for the first time. However, this paper money still wasn't real fiat money. Because this paper money could be exchanged for valuable raw materials such as gold, silver, and silk. It was not until the 13th century when the Mongolian ruler Kublai Khan came to power. He was the first ruler to introduce the fiat currency system and stopped trading systems backed by raw materials.

The rest of the world was getting a little late to the party. Europe started experimenting with fiat money in the 17th century. Another 200 years later, in the 19th century finally, also parts of North America began to deal with the concept of fiat money. The first results of the “fiat-money-experiments” differed a little from country to country. This is why not every country immediately switched to the fiat currency system but maintained its gold or silver standards.

It was not until 1972, during the presidency of Nixon, that the USA finally gave up the gold standard and introduced a currency system based exclusively on the fiat currency system. After the USA had officially introduced its new currency system most other countries in the world also started adopting and developing their fiat currencies.

How does fiat money work?

It is often wrongly assumed that fiat money is automatically the same as paper money. As shown above, paper money can also be based on the gold standard system or any other commodity. For example, the gold standard would mean, that the government can only spend as much paper money as it owns in gold. However, this is not the case with fiat currencies, there is no physically tangible equivalent for which the money could be exchanged. And here is the point, where we get to the explanation of the term fiat.

Fiat comes from the Latin language and means something like "it should" or "it should happen". This makes sense because fiat money has no intrinsic value in itself. Fiat money draws its value solely from the nominal value given by the government to it. The concept is based on the trust, reputation, and economic strength of the issuing government. And this is why some currencies are stronger or more valuable than others. Because the country and economy behind this currency are stronger.

Advantages and Disadvantages of Fiat Money

While the concept of fiat money has been used for several centuries, economists still disagree on whether it is the best solution. The following points speak in favor of a fiat currency system:

• Inexpensive: Printing paper money is significantly cheaper than minting silver and gold coins.

• Flexible: When systems like the gold standard still prevailed, banks and governments were severely restricted in their freedom of action. Because they could only spend as much paper money as their limited raw material reserves allowed. With fiat currencies, central banks now have more opportunities to influence the supply of credit, liquidity, and the flow of money in the country and to dampen negative effects on the economy.

• International: Since most of the countries in the world use the fiat currency system and recognize each other's currencies, it makes international trading much easier.

But fiat money has some important disadvantages, which can’t be ignored anymore, such as:

• No backup: Since fiat currencies have no intrinsic value, their assigned value is based solely on trust in the government. If the government and central banks fail, paper money automatically loses its value and, in the worst case, is completely worthless. Because there are no real reserves, as mentioned above like gold or other raw material, that would secure them.

• Less stability: Compared to cryptocurrencies Fiat money is less volatile. That means its value remains relatively constant. But systems such as the gold standard offer the most value stability. Because gold is a limited raw material and therefore always has a certain value.

• Inflation: Since fiat money has no intrinsic value, central banks could print any amount of money. One such case occurred in Zimbabwe in the early 2000s. The country wanted to solve its grave economic problems by printing large amounts of money. This reckless act soon showed its negative consequences. Because only a few years later it came to hyperinflation, which was between 230 and 500 billion percent. The Zimbabwe dollar became almost worthless due to the enormous supply, both in its own country and compared to other fiat currencies. The example of Zimbabwe is just one of many and represents the most dramatic case of hyperinflation.

In my next article, I’m planning to go deeper into details and explain more on Fiat money, Digital money, and Cryptos, if you are interested! I hope you enjoyed the article and it was informative.

*Lead image by Jason Leung on Unsplash