What is fiat money?

Key indicators

✔️ Fiat money has its value because it can be used to buy goods and services.

✔️ In Europe, almost all central banks are government-owned except in Switzerland where they are 100% owned and in Belgium where they are 50% owned.

What is fiat money?

The term fiat money is a fairly well-known term. Yet not everyone knows exactly what this term means and how people have handled money throughout history. Hence, we wrote this lesson.

The purpose of fiat money

Fiat (permission) money derives its value from the confidence that goods and services can be bought for it. A government enforces this by labeling it as legal tender, which means you have to accept it in an exchange. Its material value is minuscule to 0 generally.

The purpose of fiat money is to ensure that there is enough money in circulation to pay for all goods and services. If there is too little fiat money, products cannot be purchased. If there is a surplus, we have inflation.

Fiat money usually has no intrinsic value, unlike, say, gold or silver.

The history of money

Antiquity.

In prehistoric times, people traded with each other. Everyone fulfilled his task. The goal was simply to have enough to eat and a place to survive. You actually traded time. Men went hunting and in exchange, women and children went to get less dangerous creatures like tubers and lemons and women made clothes. Fine arrangements for a long time.

At one point, non-perishable goods were used as a type of money. Think of weapons and consumer items.

Early Bronze Age.

During this time, bronze objects were used as a means of payment. Bronze rings and ribs of almost equal weight were used to pay for all sorts of things.

Precious metals and variants.

In Mesopotamia around 2500 BC, people used silver as a standard. This was all recorded on clay tablets and thus we know. A silver bar was weighed and chopped into pieces where necessary. According to historians, cuneiform writing was invented specifically for this purpose.

King Hammurabi of Babylonia was a wise man. He considered a trade in silver coins around 1760 BC so important that he demanded witnesses to it. Babylonia became a powerful and prosperous empire because of his keen insights.

In China around 1500 BC, cowrie shells were used as currency. Even into the 20th century you could pay with these! At first you had to pay two shells for a woman, but by the 19th century this had increased to 1,000. Apparently, women were increasingly valued.

By 700 BC, the Chinese switched to money made of paper. They probably ran out of shells. The advantage of such a currency is that there is no limited supply of it, as with gold and silver.

The first official coins were minted in Lydia by King Alyattes around 640 BC. These were made of electrum, a mixture of silver and gold. You probably know the last king of Lydia because of the saying "to be as rich as Croesus." This one was the first to mint a gold coin, bringing enormous wealth to this small city-state. Even ordinary citizens became merchants and started the first kind of stores, selling coveted goods like perfume and cosmetics to customers from all over the then known world.

By 550 BC, Greeks were already paying with Drachmas, which means a handful. These were silver coins with a fixed weight.

Alexander the Great (356-323 B.C.) could not be left behind then. He invented a government-issued currency with an official stamp to guarantee its value and quality, making it legal tender. However, he was wise enough to allow other means of payment by region, especially given his rapid expansions. Coinage began to become mainstream.

Egypt was known around 300 BC for its grain banks, where you could pay for goods with grain.

The Romans took everything with a grain of salt, so they figured that it was best to pay with it, too. Soldiers received their salaries in salt, which was one of the most precious spices at that time and was therefore known as white gold. Salary means salt ration.

Temples had been like banks since Babylonia, because priests were seen as very honest people. Julius Caesar put an end to this, because things were much too honest. He established the first real banks and they became stinking rich in a very honest way by lending money at interest. Famous stable coins from that time were the gold aureus and the silver denarius.

History fiat money

Chinese and Mongolian paper money

Around the year 1000, the Yuan and Ming dynasties in China used paper money. Traders had to carry precious metals when trading and found it inconvenient. The government issued bills of exchange that traders could buy for precious metals to facilitate trade.

In the time of Dzhenghis Khan, paper money was used as official means of payment among the Mongols.

The wealth of the Knights Templar

During the Crusades, the Order of the Knights Templar was founded. These knights had taken a vow of poverty and all their possessions came into the possession of this order. This is how they became wealthy. Stories surrounding excavations at the Al Aqsa Mosque, where they had found the treasure of the Temple of Solomon next to Biblical relics, were probably entertaining legends.

A more obvious explanation for their wealth lay in the fact that they received all the property from each knight and their diverse sources of income, including gifts, taxes, ecclesiastical revenues and more. They had a hand in everything and at one point became the bankers of kings and popes, between 1100 and 1300.

The French king, Philip the Handsome, had borrowed a lot of money from the Knights Templar. At friday the thirteenth in the year 1307, this king had found a solution to his money problem. Declare them heretics, in cooperation with Pope Clement the 5th, who had also borrowed a lot from them, and set them all on fire. March 18, 1314, all the leaders were burned for heresy.

Jacques de Molay, the grand master of the order, shouted while being burned that both the king and the pope would die within a year. So said, so done, within a year they both died. A kind of magical veil still hangs over the Templars.

Swaps

In Europe, paper money was introduced with the bill of exchange. Merchants and goldsmiths saw its usefulness. Merchants could now travel around and trade without having to carry highly visible and heavy precious metals. They could demand bills of exchange for their merchandise that they could later exchange for gold or other precious metals.

Fractional stocks of gold

The goldsmith thought of something very clever. He saw that a lot of gold was deposited at his vault, but not all of it was collected at once. So he started lending and banking gold. This, of course, went well until there was a "bank run" and he went bankrupt. Once people realized that goldsmiths did not keep everything in physical reserves everyone naturally went to get their money as quickly as possible.

The tulip bulb

A fun interlude is the history of the tulip. There was a bubble and a fear of missing out, familiar cries from the crypto world. Around 1600, this tulip from Turkey became hugely popular in high circles. Ladies wore it in their cleavage at gala balls. A viral infection gave the flowers brightly colored flames, which greatly increased its popularity.

In 1623, you paid about a thousand guilders for a tulip bulb, 7 times an annual income. The Semper Augustus took the crown, crossing the counter for 6,000 quid. In 1636, this bubble burst. Probably some smart person figured out that you could also grow tulips yourself and when enough people did, the dilution due to excess supply occurred.

Bank

The word bank comes from the Italian language. A banca was a park bench where they conducted commercial business. Banks had looked closely at goldsmiths and held only a small fraction of equity. In the 17th century, the Bank of Amsterdam issued bearer bills, with which you could proceed to redeem the bill in specie, that is, bullion. It was soon followed by the Bank of England and the Banque de France. The latter crashed in 1721.

Fiduciary money

Fiduciary money has often been used to pay for major upheavals such as revolutions. So there is no cover for this. This usually ends in hyperinflation and the end of this money.

The Gold Standard

The gold standard, also known as the gold standard, was introduced in 1816 to make international trade easier. Because of the fixed value per unit of currency in gold, traders knew where they stood. This system continued until the 20th century.

You could always exchange paper money for gold. However, gold is not always worth the same. That is not convenient for an international medium of exchange.

If at any time there is much more economic activity you cannot simply increase the amount of gold. As a result, it inhibits growth. The end of the gold standard was imminent due to globalization and increased economic activity in the world.

Federal Reserve Bank

In 1912, JP Morgan, a puissant wealthy banker, organized a meeting on his private island of Jekyll Island. His plan was to establish a bank with other very wealthy families who owned 25% of the world. Notable attendees were the Rockefeller, de Rothschild and Warburg families.

They wanted a monopoly on money creation at interest in the US. The government would have to turn to this bank for new money. A fixed percentage of every US dollar created would go directly to these super-rich people. They called it the Federal Reserve Bank, so it didn't sound very private and people thought it was a government agency.

President Wilson and many Democrats had little faith in this. Fine, thought JP Morgan and consorts, we'll vote on it when they're around the Christmas tree. The congressmen who did attend had no idea they had just turned the financial landscape over to moneyed rich by voting for it. This scheme is also known as "The creature from Jekyll Island."

The advantage of this system was that bank runs now became virtually impossible. The Federal Reserve Bank could print unlimited dollars and support banks as needed. The government could also borrow unlimited money from them and the money flowed into this private bank by the bucketful at the people's expense.

Central bank

Central banks in Europe are almost all publicly owned, except in Switzerland (100% privately owned) and in Belgium (50%). However, commercial banks also have the right to create fiat money out of thin air, as long as they have a fraction of equity in their coffers. Bank runs are then possible, as with the Dirk Scheringa Bank, or the collapse during the economic crisis in 2008.

The central bank is supposed to keep an eye on the money supply of the national currency so that significant monetary devaluation does not occur. If money is printed in unlimited quantities, it can hurt the economy and destroy purchasing power.

The future of fiat money

With the advent of cryptocurrency, a new direction may someday be taken. With Central Bank Digital Currency (CBDC), paper money is actually being exchanged for digital money, crypto-currency.

In the history of fiat currency, there has never been a currency that has stood the test of time. Every fiat currency has experienced a tumultuous period of hyperinflation and demise. Consequently, the physical raw material for fiat money is usually without intrinsic value.

The traditional financial system tends to have limited liquidity and is not decentralized, so people may well take refuge in Bitcoin and other cryptocurrencies in countries where trust in the government and governments is low.

Cryptocurrency and blockchain can break the cycles of rise and fall of fiat money. The question, however, is whether banks, citizens and governments are waiting for this. The future will tell.