Money can seem like such an abstract concept at times. At one point, people traded physical goods to meet their needs, but as society advanced, a trade-based economy shifted to more of a service-based economy and now we use physical currency for goods and services. Canada no longer backs its money with gold and instead uses fiat currency.
Learn what fiat money is with this helpful guide.
What is fiat money?
Fiat money (or fiat currency) is government-controlled money. While the value of money was once based on the value of a country’s reserve assets of precious metals like gold and silver, fiat money derives its value from the decisions made by a country’s centralized banks.
Fiat currency has purchase power because a country’s banks and government have come to an agreement on their value. A nation’s economic stability can help preserve the value of its currency, and a government can control its money’s worth through supply and demand.
All major monetary systems around the world are fiat-based, leading some people to use the term fiat currency to describe any money used as legal tender and issued by a government, whether it’s backed by the gold standard or not.
What does fiat mean?
The word “fiat” is a Latin term that translates to “it shall be” or “let it be done.” It can be used as a word for an official order or decree. So, a fiat currency is created by a government order. The value of fiat money comes from a country’s government maintaining its value.
What gives fiat currency its value?
While physical coins may have value if actual precious metals are involved, paper money in a country with fiat currency is only worth something because it’s backed directly by its government. Since different countries may have different economies, one country’s fiat currency may have a very different value than another’s—this is known as an exchange rate. If a country’s economy is doing well, the value of its fiat currency grows as well.
Essentially, a nation’s fiat currency is worth a certain amount because its government says that’s what it’s worth. That value is accepted around the world because other countries believe in that nation’s ability to pay its bills.
Advantages of fiat money
The success of fiat currency depends largely on how stable a country and its government are. Drastic actions from a military or economic perspective can grossly affect the value of a nation’s currency, but when done correctly, there are many advantages, such as:
- Control of the money supply avoids scarcity issues.
- Economies are insulated from potential disasters.
- Counteracts economic issues by printing or holding paper money.
- Economic recovery in recessions is possible thanks to variables like liquidity and interest rates.
- Can adjust the monetary supply to suit the needs to of the economy.
Limitations of Fiat Money
Even though fiat currency is the worldwide norm among developed countries, it isn’t foolproof and there are a few drawbacks and limitations like:
- If a government pumps too much new money into an economy, it can rapidly lead to inflation.
- Fiat currency is susceptible to inflation; it may lose value in huge increments.
- The value of fiat money is tied to people’s faith in their nation’s currency. If people lose faith in it, it will cease to hold value.
Is fiat currency like cryptocurrency?
In short: no. The main difference between various cryptocurrencies and a country’s fiat currency is that crypto doesn’t require any government backing—something that’s vital for fiat money. Rather than circulating through banks, cryptocurrencies circulate thanks to a record keeping technology called a blockchain which means they don’t need a central banking authority.
While governments can create more physical money as necessary, there’s a finite supply of some cryptocurrencies, so their value is determined by supply and demand. These online currencies are more like an investment than an actual currency, and investors hoard them based on speculation about how much they’ll be worth in the future, which has caused their value to fluctuate wildly.
Send money with Western Union
Whether you’re sending essential funds to family living abroad or a little extra spending money to a cousin on a trek around the world, it’s fine for you and your recipient to use two different kinds of fiat currencies. Create an account to send money online from the Western Union site, or download Western Union’s mobile app to send money internationally, anytime, anywhere.
