Fiat currency is any government-backed legal tender that is not backed by a physical commodity. The term comes from the fact that the currency is given value based on the dictate, or ‘fiat’, of a government, and not based on some intrinsic value recognized by those who use it.
Most national currencies are based on fiat, though it was not long ago that the currencies of advanced Western nations were based on a direct relation to physically-stored gold, a practice known as the gold standard.
Prior to the gold standard, most currencies were made from precious metals, gold or silver in most cases, and the value of the currency was roughly equal to the precise value of the precious metal that it contained.
Issues With Fiat Currency
While largely recognized as an effective form of currency, fiat currency does have some implicit issues and problems that play a large role in modern economies.
The major issue with fiat currency is that it has no intrinsic value, and is under the control of fallible government institutions. This means that governments can over or under produce fiat currency, both of which can have severe impacts on the operation of an economy.
The biggest fear associated with fiat currency is that of hyper-inflation, where citizens do not want to hold their national currency for any period of time, as it rapidly loses purchasing power.
There are additional issues with the centralized management of a nation’s currency by the government that play out in discussions of central bank operations to this day, such as wealth distribution, misguided attempts at ‘economic fine-tuning’ and so on.
Fiat currency is the dominant form of currency in the modern world. Despite the many existing and potential pitfalls associated with fiat currency, it is seen as superior to its current alternatives.
However, the many severe historical failures of fiat currency and its implicit shortcomings leave it with a fair share of critics and those who continue to seek out superior alternatives.