What Is Fiat Money?

Commodity money is portable and easily transportable, which makes it convenient for use in trade and commerce. Gold and silver coins, for example, are small and lightweight, which means they can be easily carried and transported from one place to another. Contrarily, we also have commodity currencies that depend on production and consumption, such as salt and tobacco. Such goods are raw or partly refined materials whose value mainly reflects the costs of finding, gathering, or harvesting them; they are traded for processing or incorporation into final goods.

In economic terms, commodity money has what is known as an ‘intrinsic value’. Therefore, anything that has an alternate use could be considered a commodity form of money. Commodity money is a physical good that consumers universally use to trade for other goods. In other words, it is like the money we use today, but has an actual value. For example, gold was used as money, but also in the manufacturing of jewellery. That includes the $100 in physical money deposited by Customer A and subsequently Customer C. Also, the debt provided to Customer B is classified as an asset.

This backing meant that, in theory, you could take your paper money and exchange it for the corresponding value in gold. In 1913, the Federal Reserve was created and given the power to steer the economy by controlling the money supply and interest rates on loans. For example, in 1971, the U.S. dollar was taken off the gold standard—the dollar was no longer redeemable in gold, and the price of gold was no longer fixed to any dollar amount. This meant that it was now possible to create more paper money than there was gold to back it; the health of the U.S. economy backed the dollar’s value.

As previously stated, forced paper money, debt money, irredeemable paper money, and managed money are all terms used to describe Fiat money. The value of fiat money can fluctuate, which can lead to economic problems. The value of commodity money can fluctuate in order to promote economic growth. Gold is a valuable metal because it can be used to make a wide range of products. Silver is an excellent material for casting because it is soft and malleable. In the past, other commodities, such as seashells and camels, were also used as currencies.

  • Governments are in charge of regulating the amount of money in the fiat monetary system.
  • Commodity money is a physical good that consumers universally use to trade for other goods.
  • Generally, the Governmental Monetary Policy and the Monetary Policy together determine the quantity of the fiat money.

We will learn in this chapter that changes in the way people use money have created new types of money and changed the way money is measured in recent decades. fundamental analysis forex If cigarettes and mackerel can be used as money, then just what is money? A medium of exchange is anything that is widely accepted as a means of payment.

For example, gold has intrinsic value because it is used in jewellery, electronics, and other industrial applications. In metallic currencies, a government mint will coin money by placing a mark on metal tokens, typically gold or silver, which serves as a guarantee of their weight and purity. In issuing this coinage at a face value higher than its costs, the government gains a profit known as seigniorage.

Medium of Exchange

When the central bank buys these government securities, it puts money into the marketplace, and effectively into the hands of the public. As strange as it sounds, the central bank simply creates the money and transfers it to those selling the securities. Alternatively, the Fed can lower interest rates allowing banks to extend low-cost loans or credit—a phenomenon known as cheap money—and encouraging businesses and individuals to borrow and spend. In 1913, in response to the panic of 1907, the Federal Reserve in the U.S. was established and acquired the authority to control the money supply, and the quantity of money produced. In 1933, during the Great Depression, President Franklin D. Roosevelt suspended the gold standard. He issued an executive order that required all citizens to turn in gold in exchange for dollars in an attempt to inflate the money supply and help fight the economic downturn.

The origins of fiat money come from the Chinese Tang dynasty in the 11th Century. By the 12th Century, fiat money had become widely used throughout the country. The first use of paper money occurred in China more than 1,000 years ago. By the late 18th and early 19th centuries, paper money and banknotes had spread to many other parts of the world.

Futures and options are listed on exchanges and have standardized contracts that are more highly regulated. Trading commodities goes back to the dawn of human civilization as tribal clans and newly established kingdoms would barter and trade with one another for food, supplies, and other items. Commodity trading predates that of stocks and bonds by many centuries. The idea is rooted in the fact that we only ever experience deflation, across the entire economy, at times when consumer spending collapses for one reason or another.


Governments and central banks can simply create more of it when needed. Although, with that said, this was also a common occurrence under commodity money, as rulers would simply reduce the level of gold content in the coins it issues. A medium of exchange refers to currency or other things that are used within a market to exchange goods and services within the economy. Some examples of a medium of exchange include fiat currency, gold, cryptocurrency, and commodity money. A paper money is a type of exchange that is neither backed by physical goods nor regulated by any market.

Many online financial portals will provide some indication of certain commodities prices such as gold and crude oil. Today, it lists options and futures contracts on a wide range of products including gold, silver, U.S. The Chicago Mercantile Exchange (CME) Group merged a big loss with the Chicago Board of Trade (CBOT) in 2007, adding interest rates and equity index products to the group’s existing product agricultural offerings. Perhaps the most influential modern commodities market is the Chicago Board of Trade (CBOT), established in 1848.

Examples of fiat money

Historians generally ascribe the first use of coined money to Croesus, king of Lydia, a state in Anatolia. This relationship between money and gold provides insight into how money gains its value—as a representation of something valuable. The lack of transferability of bartering for goods is tiring, confusing, and inefficient.

How Is Money Measured?

So, whether you’re reading an article or a review, you can trust that you’re getting credible and dependable information. Mercedes Barba is a seasoned editorial leader and video producer, with an Emmy nomination to her credit. Presently, she is the senior investing editor at Bankrate, leading the team’s coverage of all things investments and retirement. During the Age of Exploration in the 15th and 16th centuries, European nations began to establish colonies in the Americas, Africa, and Asia, leading to the development of global trade networks. This led to the emergence of international currencies like the Spanish dollar and the Dutch guilder.

Government fiat money has lost its initial worth as a result of governments’ decreasing willingness to back it up with gold or other commodities throughout time. It was initially created as a practical way for citizens to carry paper that was backed by the government rather than lugging about gold or silver. Commodity money is a kind of payment that has the potential to transform into a good or service for production or consumption. For instance, metals such as gold, silver, and others were used to create jewelry as well as to exchange for things in the early days. As a result, it served as a means of exchange as well as having some other worth.

What Is Commodity Money And How Does It Work?

Money is valuable because we want it, but we want it only because it can get us a desired product or service. Fiat money becomes the token of people’s perception of worth, the basis for why money is created. An economy that is growing is apparently succeeding in producing other things that are valuable to itself and other economies. The stronger the economy, the stronger its money will be perceived (and sought after) and vice versa.

The Use Of Paper Money: Pros And Cons

The lack of spending during these periods is bad for business as it implies unsold goods, which leads to reductions in production and increased unemployment due to redundancies. That in turn leads to even less money being spent and micro silver futures a downward spiral of economic output reminiscent of what occurred during the Great Depression. The evolution of money has not always unfolded in a constant progression from a basic form of money to a better form of money and so on.

As seen in Figure 3, as the demand for a commodity shifts in (less demand) the quantity decreases to q’. This decreased demand is likely to decrease GDP, as less exporting takes place, as demonstrated by the equation for GDP below. Even though traders may not accept it; the population was left reassured that it had alternate uses. The creation of units of measurements such as ounces and pounds paved the way for such. As a result, we are able to purchase different goods at different prices.