Fiat Money Definition

A Brief History of Money

You are Money - Believe It!

A fiat money definition is that it is nearly all of the legal tender circulating in a country. It has no intrinsic value whatsoever. The notes and coins used in commerce and by the population in general are money by decree. The Government says, by regulation or in law, that these objects are to be items of exchange and legal tender in the settlement of debts. "Fiat" is Latin, meaning "It shall be". The government says "These notes and coins are money." and so that they become. This is a fiat money definition. Their legitimacy rests solely upon the confidence that people have in the government. The following comments are based loosely upon the system of the United States Government but most countries follow similar principles and practices. Knowing what has developed in the past will give everyone, including retirees, the ability to estimate and be forewarned of the future.

In his paper Bitcoin : The Money Revolution : A New Currency For a Free Society (Copyright - - All Rights Reserved) David Macgregor moves smoothly from the origin of money as precious metals, gold and silver, to the current debt-based fiat money. For his subject the matter of the detail of the transition from one to the other is not important. He mentions fractional reserve banking whereby banks "create money" by making loans. This short piece amplifies a fiat money definition.

Banks once issued receipts for the gold and silver deposited with them and very quickly these receipts were themselves used as money. The banks also noticed that only a small proportion of the deposits was ever required by owners at any one time. They therefore "felt free" to "lend" in the form of notes or records in books of deposit sums equal to the value of the majority of the actual precious metal held. This worked well so long as depositors did not all demand their funds at the same time. Actual deposits were soon far exceeded by the loans made. The small sum that the banks held to deal with day to day transactions in "real" money were their reserve funds. The created "fiat money" as defined far exceeded the reserve funds although at first it was by mutual understanding between people and traders that the "paper" money was accepted. It was later that governments took over framed an official fiat money definition which made the "paper" legal tender.

The government faced the problem of funding its expenditure by the very characteristics that made gold and silver ideal as money. It was accepted as uniquely precious, was divisible, was convenient but was also, unfortunately for profligate governments, in limited supply. A way round this problem was soon found.

The Federal Reserve

The government outsourced the issue of money. It created a body, the Federal Reserve, which is not a part of the government, that was given the right to print notes, money, to the order of the government. It was fiat money by definition of the government. This money was needed to fund its expenditure on the wages of its employees, infrastructure commitments and other things. The government provided receipts for the money printed. At first the government attempted to ensure that it could "cover" the value of the notes printed with the gold and silver that it held. It was soon obvious that the cash that the government required for its works would exceed its reserves of real assets. The debt characteristic of the fiat money definition became very real. It has been the cause of financial crises in the past and will lead to more problems in the future.

We Make Money!

The way round this problem was for the government to issue the orders for the money that it needed with interest bearing notes that could be redeemed in a fixed period. It made the Federal Reserve the only body that could deal in government bonds. It further made it necessary for private banks to hold a prescribed percentage of their total deposits as mandatory reserves. These reserves could be held in cash, real assets, or in government bonds. The government was also able to determine the proportion of cash and bonds that needed to be held and it further required that these reserves be held by the Federal Reserve. The government thus established control over the economy of the country. If it was deemed necessary to restrict the credit available the government could simply increase the amount that a bank had to hold in reserve and the proportion that had to be held in government bonds. To meet such new requirements banks had to purchase further bonds from the Federal Reserve. This restricted the amount that they had available to lend to customers. The reverse could also apply if economic conditions merited an increase in available credit. Local banks could only deal in government bonds with the Federal Reserve. The latter body could deal with anyone and sold the bonds to foreign governments and institutions that felt that holding a commitment by the issuing government was a good investment and a good earner by virtue of the interest paid on the bonds.

Governments across the globe have adopted the practice of issuing IOUs, or debt commitments, to obtain cash. Very soon it became clear that the government could not match the amount of money printed and in circulation with its reserves of precious metals. Most governments of First World western nations have now reneged on their original promise to provide holders of their printed money with actual gold on demand. The "value" of the stuff that a government calls money is based only upon the acceptance of that legal determination by those who use it. The government says "It shall be money" and it is, "fiat" money. This is a fiat money definition.

Fiat Money Definition : Does it Work?

All Down The Pan - Eventually

The answer to this question is a qualified "yes". In many countries the fiat monetary system has collapsed. It did so in the Weimar Republic in Germany between the First and Second World Wars. It has done so more recently in Argentina and Zimbabwe. No fiat currency has survived in the long term and there is nothing to suggest that any will do so. It seems clear that money created out of or by debt cannot be considered stable except for short periods. Even a hundred years is a short time in a nation's history. It would also appear to be obvious that debt cannot be ultimately or forever be repaid by further and increased borrowing. This is a serious and limiting problem caused by adopting a fiat money definition for practical financial dealings on a domestic or international basis.

For their own safety and for reasons of asset preservation retirees must keep abreast of current affairs in economic and financial matters. An eye must be trained on indicators of national financial failure. Persistently high and rising inflation, high and increasing unemployment, corruption at high levels of the administration and falling national output are all indicators of financial trouble ahead. As those in Ireland, Cyprus and Greece have learned recently there is no point in transferring hard won pensions and annuities to places where governments are about to adopt capital confiscation methods to solve their debt problems caused by the adoption of a fiat money definition for practical needs. The size of a country and its international status are no protection. It should be remembered that it is within the memory of many now still living that the U.S.A. confiscated personal gold holdings only to sell it back to owners at vastly increased prices. Asset protection and preservation are vital to retirees. As a class they have the least time and opportunity to recover from a disaster.

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