Fiat money is currency which derives its value from government regulation or law. The term derives from the Latin fiat ("let it be done", "it shall be"). It differs from commodity money and representative money. Commodity money is created from a good, often a precious metal such as gold or silver, which has uses other than as a medium of exchange (such a good is called a commodity), while representative money simply represents a claim on such a good. The first use of fiat money was recorded in China around 1000 AD. Since then, it has been used continuously by various countries, concurrently with commodity currencies. After World War I, governments and banks generally still promised to convert notes and coins into their underlying nominal commodity (redemption in specie) on demand. However, the costs of the war and the required repairs and economic growth based on government borrowing afterward made governments suspend redemption in specie. Some governments were careful of avoiding sovereign default but not wary of the consequences of paying debts by consigning newly printed cash which had no metal-backed standard to their creditors, which led to hyperinflation – for example the hyperinflation in the Weimar Republic. From 1944 to 1971, the Bretton Woods agreement fixed the value of 35 United States dollars to one troy ounce of gold.[23] Other currencies were pegged to the U.S. dollar at fixed rates. The U.S. promised to redeem dollars in gold to other central banks. Trade imbalances were corrected by gold reserve exchanges or by loans from the International Monetary Fund. The Bretton Woods system collapsed in what became known as the Nixon Shock. This was a series of economic measures taken by United States President Richard Nixon in 1971, including unilaterally canceling the direct convertibility of the United States dollar to gold. Since then, a system of national fiat monies has been used globally, with freely floating exchange rates between the major currencies. A central bank introduces new money into the economy by purchasing financial assets or lending money to financial institutions. Commercial banks then multiply this base money by credit creation through fractional reserve banking, which expands the total supply of broad money (cash plus demand deposits). In modern economies, relatively little of the supply of broad money is in physical currency. For example, in December 2010 in the U.S., of the $8853.4 billion in broad money supply (M2), only $915.7 billion (about 10%) consisted of physical coins and paper money.[25] The manufacturing of new physical money is usually the responsibility of the central bank, or sometimes, the government's treasury. The adoption of fiat currency by many countries, from the 18th century onwards, made much larger variations in the supply of money possible. Since then, huge increases in the supply of paper money have taken place in a number of countries, producing hyperinflations – episodes of extreme inflation rates much higher than those observed in earlier periods of commodity money. The hyperinflation in the Weimar Republic of Germany is a notable example. Economists generally believe that high rates of inflation and hyperinflation are caused by an excessive growth of the money supply.[26] Today, most economists favor a low and steady rate of inflation.[27] Low (as opposed to zero or negative) inflation reduces the severity of economic recessions by enabling the labor market to adjust more quickly in a downturn, and reduces the risk that a liquidity trap prevents monetary policy from stabilizing the economy.[28] However, money supply growth does not always cause nominal price increases. Money supply growth may instead lead to stable prices at a time in which they would otherwise be falling. Some economists maintain that under the conditions of a liquidity trap, large monetary injections are like "pushing on a string."[29][30] The task of keeping the rate of inflation low and stable is usually given to monetary authorities. Generally, these monetary authorities are the central banks that control monetary policy through the setting of interest rates, through open market operations, and through the setting of banking reserve requirements. https://en.wikipedia.org/wiki/Fiat_money

• published: 11 Oct 2015
• views: 132