Of the latest batch of new glossary items I have posted about this morning the most important for many readers of the blog may be the one on fiat currency. For that reason I share it here because this is an issue which many people do not understand until it is explained to them:
Fiat money is the currency of a country that is declared to be the legal tender of that jurisdiction by its government.
A fiat currency has status as legal tender as a result of legal declaration, and nothing else. It is not backed by any physical commodity or asset, such as gold or silver.
The value of the currency is instead determined nationally by the ability of the country that declares it to be legal tender to impose taxes on its population and to then collect them.
Internationally, the value of a fiat currency is determined by the relative trading strength of the country that issues it, and its perceived political stability, although short-term variations in the value of a currency might arise for speculative reasons.
Since the United States abandoned the gold standard in 1971, almost all the world's currencies are fiat currencies.
Since a fiat currency can ultimately only be created by a government it is government expenditure funded by the government of a jurisdiction borrowing from its central bank that gives rise to the creation of all fiat currency.
Taxation exists to withdraw the fiat currency that a government has put into circulation through it expenditure from circulation to the extent that is considered necessary to control the risk of inflation arising (see reasons to tax).
In a fiat currency system, government expenditure, the scale of a government deficit, taxation, and the control of inflation (see separate entries) are as a consequence all intimately related issues. This makes the artificial disaggregation of macroeconomic policy into fiscal policy and monetary policy deeply harmful to the overall control of the economy of a jurisdiction by its government.
A proper understanding of fiat money also puts it at the heart of macroeconomics, when at present it is treated as peripheral to that subject by neoclassical economics, or is even ignored by it.
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There are many examples vb of the dangers of printing money. Here is another from this mornings FT ..
https://www.ft.com/content/acca94f3-6bad-4832-94fc-563865d4e241?segmentId=6bf9295a-189d-71c6-18fb-d469f27d3523
But this is Argentina
Borrows in dollars
Has low taxes
Does not collect enough of taxes owing
Their situation is so very different to ours
The solutions to their problems are also clear
The point is that the political West’s whole economy is based solely on fiat currency (this includes major eastern economies – India, Japan). Britain, the EU and crucially the almighty dollar. Indeed here is how far it goes: China’s Yuan (renmenbi) is pegged to the US dollar. Indeed the peg (which suits China more than the US – it manages a “dirty” or “floating” peg, because that is what preserves its world trade advantage) merely emphasises the key importance to the whole world economy of the US dollar: a fiat currency. Of course anything can go wrong, this is the real world; but all economies rely on the capacity to have confidence in a currency, and in the modern world we recognise there is a difference between functioning currency, on which an economy depends on money, and not a single commodity.
And you present Argentina as a critical proof – of The folly of printing money? Mr Mackenzie, would you care to stand up some evidence why your remote outlier is in fact, the central case?
This might be silly but is it worth pointing out that “fiat” means “by decree” and is not a small car?
Yes
I will add it
PS Glossary now changed
Sovereignty.
We live in a world dominated by the idea that government’s cannot do anything for the people. States have been gelded into ineffectiveness by free market dogma.
Your entry needs to boost the sovereignty angle to counter this in my view – to tell people that the State has the power to help in order to create the expectation that it will. It will also counter the BREXIT lies that sovereignty lies only in borders and laws.
The sovereignty aspect also boosts the idea that the State can (if it wishes) control the banking sector more effectively if it wants to.
Fiat money, MMT are all aspects of State power that are refuted by Neo-liberals.
Technically robust as your entry is, it needs to appeal to the idea that the State can do better – perhaps?
Entry updated
Is there an equivalent simple expression to denote a currency that is not “fiat”? Sometimes it helps to explain a concept, if there is a simple and opposite idea against which to contrast it.
For example: A fiat currency is one where….., as opposed to a ???? currency, which relies on …
Apologies if this a bit obtuse.
As opposed to an asset backed currency, of which there aren’t any?
Yes, thanks.
Richard
Perhaps a real life, basic, numerical example would help to cement the understanding of fiat currency and money creation.
I have tried that and am not sure it did help
It is decidedly complex
Richard, it might be clearer to use a money flow diagram to clarify the creation, flow through the economy and cancelled through tax.
It may be, but only if I could work out how to draw it and I do not think that was
Sorry