What is Fiat Money and how is it printed?

We all have heard the term fiat sometimes, somewhere. Even the Indian currency INR is also a fiat money. These fiat currencies are quite easy to issue, as the government or the central bank has not to issue any backup commodity for it. But at the same time, fiat money is quite risky as it can lead to high inflation of the economy. 

 

At the same time, these currencies can not be redeemed back. Discover the meaning of fiat money and the process of its printing. 

 

 

What is Fiat Money?

 

Before jumping to the main topic, first let us clear the meaning of a few important terms in mind. The word ‘fiat’ is a latin term. The general English meaning of fiat is translated as “let it be done”. As the name shows, fiat currencies will only have value because of the government or the organizational efforts. The fiat money itself has zero utility value.

 

Fiat money is a kind of government-issued currency. But like other currencies, fiat money is not backed by a physical commodity like gold or silver. Rather the value of fiat money is backed by the government that issued it.the value of a fiat currency is dependent on the relation between supply and demand. 

 

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Rather than the worth of commodities backing it, fiat money and its stability is dependent on the stability of the issuing government. More stable the government is, the more will be the value of fiat money and vice versa. 

 

Fiat money empowers the central banks more control over the economy as they can control how much money is printed. 
 

 

Characteristics of the fiat money

 

1. Fiat money is not backed up by any physical commodity such as gold or silver.

 

2. It eases the process of minting physical commodities for the government.

 

3. Fiat money is inconvertible.

 

4. Fiat money can’t be redeemed as there is no physical commodity backing it up.

 

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5. The over printing of fiat money can lead to a critical situation, called hyperinflation.

 

6. Fiat money is not linked to any physical reserves.

 

7. Fiat money risks losing value. Sometimes, the loss is almost double or more than that to the original value.

 

8. If the citizens lose faith in a nation’s currency, the value of fiat money will automatically become zero.

 

9. Unlike fiat money, the backed up money has some intrinsic value .

 

10. Fiat money is too different from the currency that is backed by gold or silver.

 

Examples of the fiat money

 

From the definition of fiat money in the above paragraph, it is clear that the money issued by the government on its own terms and risks is counted as fiat money. From this, the fact can be driven that almost all the paper currencies are fiat currencies.

 

For example, the US dollar, the Euro, the Indian Rupee, and the British Pound.

 

While when we talk about non-fiat money, all hard money is counted in the mentioned category.

 

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How is the Fiat Currency printed?

 

Process of issuing fiat currency

 

Now the question arises, how is the fiat currency printed. Here's the entire process.

 

1. A new money is introduced by the central bank by purchasing financial  assets or lending money to financial institutions.

 

2. This base money is then used by the commercial banks to redeploy or repurpose by credit creation. The entire process is guarded through a fractional reserve banking system. The system expands to the total supply of broad money.

 

3. Broad money stands cash plus demand deposits.

 

4. The production of new fiat money is generally the responsibility of the government or the national bank.

 

5. The government accesses the fiat money production backed by the full faith and credit.

 

6. Rather than lawful money, the fiat money is considered as the legal tender. Lawful money is the money which can be exchanged for gold, silver or any other commodity.

 

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Can fiat money cause hyperinflation?

 

As fiat money is not backed up by any physical commodity, thus there can be a possibility of the government printing it without any restrictions or laws. Because of this reason, the fiat currency system can lead to hyperinflation or high inflation. 

 

Though, some consistent low level of inflation is a positive driver of the economy. As it encourages the organizations and individuals to invest their money to work rather than sit idle and lose purchasing after some time. 

 

But hyperinflation can be a solid cause to destroy the economy of the country. Even in the traditional times, when hyperinflation occurred, the entire kingdom collapsed. If not tackled with proper concern and care, the fiat currency can ruin the entire system of economy and stability of the nation.

 

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What are the alternatives to fiat money?

 

The alternatives to fiat money are legal tender, barter exchange of precious metals like gold, and cryptocurrencies like bitcoins and ethereum. But these systems are not used by the governments as they are more complex for the common man and his mind.

 

Does fiat money ever collapse?

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List of well known collapsed fiat currencies

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The average lifespan of fiat money is 35 years. There are the many currencies that has collapsed due to corrupt or incompetent monetary policymaking. Hyperinflation is also a chief cause leading to the failure of fiat money. The list of fiat money that has collapsed are as follows:

 

1. Germany – 1 billion mark, 1923

 

2. Greece – 25,000 drachmas, 1943

 

3. Hungary – 10 million pengo, 1945

 

4. Central Bank of China – 10,000 CGU, 1947

 

5. Peru – 100,000 intis, 1989

 

6. Russia – 10,000 rubles, 1992

 

7. Zaire – 5 million zaires, 1992

 

8. Zimbabwe – 100 trillion dollars, 2006

 

A country’s currency is about to be buried when the total debt to GDP ratio of your country reaches 20%.

 

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What are the pros and cons of fiat money?

 

Fiat money has many advantages as well as few disadvantages. Mentioned below are the pros and cons of the fiat money.

 

Pros of the fiat money

 

The merits of the fiat money are as follows:

 

1. Fiat money gives control to the government over the economy directly through the central bank. Basically these types of currencies are government backed legal tender so the government has full control over the currency. 

 

The production and circulation of such currencies are controlled by the Central banks, thus they control the money supply and banking system in a country. 

 

2. The government controls the economy through the monetary policies which further includes the controlling of the money supply to address the inflation and so control the economy activity and aggregate demand.

 

3. If any country is going through tough times then the government can manage how much money is circulated so this allows them to increase or decrease the fiat money. They can either increase or decrease the interest rates and the credit limits.

 

4. Fiat money is quite reliable aa compared to other currencies like cryptocurrency, gold and other assets that can fluctuate at any point. The value of fiat money remains quite stable, it won't rise or down by the drop of thousands dollars in a minute as Bitcoin.

 

5. Fiat currencies are easy to store and manage. If you have money you can simply keep it in your home or you can keep it in a bank too. Relying on any third party is not a good idea. 

 

6. It's very easy to invest from fiat currency through the linked bank account.

 

Cons of the fiat money

 

The limitations of fiat money are as follows:

 

1. Fiat money takes a long time to transfer. For example if you want to transfer the money across the globe then it can take days too for this and it will cost extra fees for this too. 

 

2. If you want to buy gold online then it is also a difficult process. You have to add your bank account and must verify your identity and it will charge extra fees too.

 

3. Inflation is also a problem. Fiat money can be produced indefinitely but it's value dilutes over time. The United States is a big supporter of this and they have printed much more dollars in a hard time too but this can be a short term solution but it weakens the dollar too.

 

4. They charged more fees without any reason.

 

5. It is very easy to get away with fiat currencies so the crime rates are often.

 

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A way forward

 

Fiat money is an integral part of the fiscal economy. If the system collapsed it would be quite difficult for the government to issue other forms of money. But at the same time, efforts must be taken by the government to ensure that the system doesn't cause blockage and hyperinflation in the market.