Fiat money and the modern economy: How does today's money differ from the gold standard?

What is fiat money really?

Fiat money is a legal tender whose value does not derive from a physical commodity but rather from the issuing government's sovereignty and economic strength. Simply put, fiat money is valuable because the government says it is. The strength or weakness of this form of money is directly related to the economic stability of the issuing country. The vast majority of the global economy is currently based on such a system, which serves as the main basis for purchasing goods and services, investments, and savings.

Why did we abandon the gold standard and commodity-based monetary systems?

In the era of the gold standard, every paper currency was backed by a specific amount of physical gold that governments held in reserve. This meant that the creation of money was constrained - new currency could only be issued if the actual gold reserves allowed it.

The transition to fiat money was gradual. The United States ended the gold convertibility in 1933, and then in 1972, President Richard Nixon permanently severed the direct link between the US dollar and gold. This decision internationally ended the gold standard and paved the way for the global spread of fiat currency. The change was not coincidental - the gold-based system was too rigid for a rapidly evolving global economy.

Fiat money vs cryptocurrency: A truly new opposition?

Although both systems lack physical commodity support, fiat money and cryptocurrency fundamentally differ from each other. Fiat money is controlled and managed by central authorities - governments and central banks. In contrast, cryptocurrencies are decentralized and are supported by a distributed digital ledger known as blockchain.

Another critical difference lies in the logic of money creation. In the fiat system, banks can essentially create money out of nothing, according to economic needs and monetary policy. However, Bitcoin and most cryptocurrencies operate with a limited, pre-defined supply. This contrasts the flexibility of fiat money with the pre-defined nature of cryptocurrency.

Due to their digital nature, cryptocurrencies are more limited in international transactions, irreversible, and harder to track. However, the size and volatility of the crypto market still surpass that of traditional markets, which explains why they have not yet become widely adopted.

Historical Lessons of Fiat Money: From China to the United States

The history of fiat money dates back over a thousand years. The Chinese province of Sichuan began issuing its paper currency in the 11th century, which could initially be exchanged for silicon, gold, or silver. However, under Kublai Khan's rule in the 13th century, the fiat system became completely mandatory rather than optional. Historians believe that the excessive expansion of this system, coupled with the emergence of hyperinflation, contributed to the decline of the Mongol Empire.

The 17th-century fiat experiment in Europe was introduced by Spain, Sweden, and the Netherlands. However, for Sweden, the system failed, and they eventually returned to the silver standard. The federal government of the United States experimented with fiat money several times in the 18th and 19th centuries with mixed success before reverting to the gold standard.

The advantages: Why is fiat money beneficial in economic flexibility?

The fiat money system has several practical advantages that support the modern economy:

Economic Flexibility: Fiat money allows governments and central banks to respond quickly to economic crises. Partial reserve banking and monetary easing act as effective tools in these situations, which would not have been possible under the gold standard.

Production Efficiency: The production of fiat money is more cost-effective than that of commodity-based currencies, which require expensive infrastructure and storage solutions.

Global Trade: Fiat money is a universally accepted medium of exchange that facilitates international transactions and the processes of value exchange.

Without physical burden: Unlike gold-backed currency, fiat money does not require physical reserves, storage spaces, security measures, and the associated costs.

The Risks: What dangers are hidden in fiat currency?

However, the fiat money system has more serious weaknesses that economists have pointed out multiple times:

Lack of intrinsic value: Fiat money has no real intrinsic value, which tempts governments to create money out of thin air. Its uncontrollability can lead to hyperinflation and ultimately to economic collapse.

Historical Risks: Throughout history, the introduction or expansion of fiat currency systems has regularly led to financial collapses, indicating that these systems carry inherent risks.

Political dependence: The value of fiat money directly depends on the political stability of the issuing country and its economic decisions, which can make the future of the currency unpredictable.

The Possibility of the Return of the Gold Standard

Supporters of the gold standard argue that a commodity-based currency system would be fundamentally more stable, as it is backed by something concrete and valuable. In contrast, advocates of fiat money point out that the price of gold has never been stable - it has shown significant fluctuations throughout history. Ultimately, fluctuations can occur in both systems, but fiat money provides greater flexibility in managing economic crises.

The Future: Fiat Money or an Alternative System?

The basic idea behind the creation of Bitcoin and cryptocurrencies was to establish a decentralized, peer-to-peer based alternative economic network. The goal is not necessarily to completely replace fiat money, but to create a parallel system that operates on different principles.

The future of fiat money remains uncertain. Although cryptocurrencies still have a long way to go and face numerous challenges, the history of fiat money demonstrates its own vulnerabilities. Therefore, it is worth looking for alternative financial solutions that could lay the groundwork for a safer and more sustainable economic system for the future.