What Is The Fiat Money System?
Fiat money is not backed by a physical investment or commodity such as gold, and is based instead on the scarcity and the faith placed in the money by those who use the it. There is no restriction on the amount of money that can be created, or rather printed, and it can vary for each different country based on their economy and financial situation. This is why a US dollar can be worth so much in China, and worth so little in other countries, based on the relativity of the currency exchange, which was also created with the fiat money system.
The fiat money system is not foolproof, as anyone can see as of late, and it is historically accurate that all paper money systems have failed in the past, causing people to revert to gold usage once again. It surely is only a matter of time before the present system collapses and things go back to the way that they once were.
For an example of how the fiat system works, consider the current economic situation. The economy is in crisis, which is slowly dragging down the value of the dollar because people are afraid to invest in it. That lack of faith is precisely what the dollar is valued upon, and once the economy rebounds, people’s faith will be restored, as will the dollar’s value.
Fiat money is generally created when there is excessive public debt such as with the recent signing of the Economic Stimulus Act by Barack Obama. The government cannot repay the debt in gold or silver, so they use the fiat system and print it rather than defaulting on the loan. For more than 200 years, the U.S. has gone back and forth between the fiat system and the gold standard, which has saved the country from suffering a complete termination of currency due to hyper inflation. Money is based on confidence, and when that confidence is lost, so is the value of the money. Gold has always been there to back up the fiat money system for more than 3,000 years into history.
The first instance of fiat money can be found in 1862 in the U.S. These bills were known as greenbacks, and were used to pay for the cost of the Civil War, which was rather outrageous and not repayable by gold or silver. They were issued with a government promise and a gold certificate, stating that the money would be repaid at a later, unspecified date. From 1880 to 1914, the U.S. returned to the fixed gold standard for a form of currency. Then, in 1915, they switched back to the floating fiat money for ten years to pay for WWI. The money wasn’t backed by gold simply because there wasn’t enough. Therefore, all currency was matched to the U.S. dollar, and that was how money was exchanged and spent. We have now been in a floating fiat currency movement since 1973, and will remain there until the system fails again and needs to be replaced with gold once more.