Why Do Most Nations Use Fiat Money Today?

The primary reason nations use fiat money today is that it doesn’t limit how much of their currency they can put into circulation.

This reality starts with the meaning behind the word “fiat”…

The term fiat may sound obscure, even mystical, but it’s actually straightforward. Fiat is Latin for “let it be done,” or “it shall be.” Apply that definition to money and it simply means that currency is “money” because a government says its money. The dollar bill in your wallet is money by government decree.

It also means that this form of “money” is not backed by anything — gold, for instance. If a nation is on a gold (or silver or other commodity) standard, the government can only circulate the amount of currency that corresponds directly to the amount of gold it owns, which would increase slightly each year. Gold has worked well in the past, because the amount of new gold coming to market each roughly corresponds to the growth in the US population.

The gold/currency connection has not always been a one-to-one relationship. For example, at one point the U.S. was on a 40% gold standard, meaning 40% of its money supply was “backed” by gold, and the other 60% was not. The US was also on a bimetallic standard in its early history, with both gold and silver backing the currency supply. You can get a quick view of US monetary history is this graphic.

Either way, the point is that a government is restricted to circulating only the amount of currency that corresponds to the value of the commodity backing it. They can’t circulate more, which thus limits government spending.

Ergo, if they have no gold standard or other restriction, they can circulate more currency as they see fit. It allows them to spend more “money” (and the modern system is set up to promote more and more spending). Any excess is simply added to the national debt.

This is why…

Fiat = Faulty

The problem with a government’s ability to spend more than its income is that it eventually does just that. The need may be legitimate, but as it prints more and more of the currency — whether by paper notes or digital entries — the value of that currency begins to dilute.

This is what forms the basis of inflation: as consumers, we eventually are forced to spend more currency units to buy the same the amount of goods and services. Even “low” inflation adds up over time; believe it or not, the Consumer Price Index (CPI) has risen 50% just since the year 2000 (as of September 2018), making a $20,000 car now cost $30,000. The effect is the same in high or even hyper-inflation, only faster.

This erosion effect is what inevitably happens when a nation uses a fiat currency. The slow drip-drip-drip of currency dilution eventually forces prices up, because leaders eventually succumb to the temptation to create more and more currency to solve their financial problems.

Some type of commodity standard would limit that dilution. But history tells us that fiat currencies eventually fail. Believe it or not, the only remaining currencies from history still in use today are the UK Pound and US dollar — and even those have undergone numerous alterations and from gold backing to no backing over the years.

So even if you save diligently in your own currency, the purchasing power of those savings erodes over time. Sometimes slowly, sometimes quickly, but on a long-term basis the buying power of a fiat currency erodes.

Is there a better long-term savings method than a fiat currency?

Gold vs. Fiat Currency

One of the crucial promises of money is that it serves as a long-term store of value. Here, fiat currency has consistently demonstrated that it ultimately fails, while gold fulfills the promise.

Look how much purchasing power all major government currencies have lost compared to gold since the year 1900.

All Major Currencies Have Depreciated Relative to Gold 

This shows that gold has been a better long-term store of value than all major fiat currencies. There were short-term periods where currencies grew in value more than gold, but over the long term, this chart highlights how fiat currencies lose purchasing power over time.

The Scary Trajectory

It’s never happened before in recorded history. And it remains to be seen what the full ramifications will be.

For the first time in history, all of today’s currencies are fiat.

None of today’s currencies are backed by any commodity standard. None are bound by an official restriction that limits how much they can put into circulation.

Studies show that fiat currencies eventually undergo frequent resets. This even includes reserve currencies of the world, such as the US dollar today.

Regardless of what may lie ahead for the global currency system, you don’t have to be bound to a fiat currency system. You can start your own gold standard. It is the one form of money that has superseded all others.