Fiat money originated in 11th century
China,[2]
and its use became widespread during the
Yuan and
Ming dynasties.[3]
During the 13th century,
Marco Polo described the fiat money of the
Yuan Dynasty in his book
The Travels of Marco Polo.[4][5]
The
Nixon Shock of 1971 ended the direct convertibility of the
United States dollar to gold. Since then all
reserve currencies have been fiat currencies, including the U.S.
dollar and the
Euro.[6]
Characteristics
The term fiat money has been defined variously as:
- any money declared by a government to be
legal tender.[7]
- state-issued money which is neither convertible by law to any
other thing, nor fixed in value in terms of any objective standard.[8]
- money without
intrinsic value.[9][10]
While gold- or silver-backed
representative money entails the legal requirement that the bank of
issue redeem it in fixed weights of gold or silver, fiat money's value
is unrelated to the value of any physical quantity. Even a coin
containing valuable metal may be considered fiat currency if its
face value is higher than its market value as metal.
History
Early history
Song Dynasty
Jiaozi, the world's earliest paper
money.
The
Song Dynasty in
China was
the first to issue paper money,
jiaozi, around the 10th century AD. Although the notes were
valued at a certain exchange rate for gold, silver, or silk, conversion
was never allowed in practice. The notes were initially to be redeemed
after three years' service, to be replaced by new notes for a 3% service
charge, but, as more of them were printed without notes being retired,
inflation became evident. The government made several attempts to
support the paper by demanding taxes partly in currency and making other
laws, but the damage had been done, and the notes fell out of favor.[11]
The successive
Yuan Dynasty was the first dynasty in China to use paper currency as
the predominant circulating medium. The founder of the Yuan Dynasty,
Kublai Khan, issued paper money known as
Chao in his reign. The original notes during the Yuan Dynasty were
restricted in area and duration as in the Song Dynasty.
Europe
All these pieces of paper are, issued with as much solemnity and
authority as if they were of pure gold or silver... and indeed
everybody takes them readily, for wheresoever a person may go
throughout the
Great Kaan's dominions he shall find these pieces of paper
current, and shall be able to transact all sales and purchases
of goods by means of them just as well as if they were coins of
pure gold.
During the 13th century,
Marco Polo described the fiat money of the
Yuan Dynasty in his book
The Travels of Marco Polo.[4][5]
In 1661,
Johan Palmstruch issued the first regular paper money in the West
(although
Washington Irving records an earlier emergency use of it, by the
Spanish in a siege during the
Conquest of Granada), under royal charter from the Kingdom of
Sweden, through a new institution, the
Bank of Stockholm. While this private paper currency was largely a
failure, the Swedish parliament eventually took over the issue of paper
money in that country. By 1745, its paper money was inconvertible to
specie, but acceptance was mandated by the government.
[12]
Fiat money also has other roots in 17th century Europe, having been
introduced by the Bank of Amsterdam in 1683.[13]
18th and 19th
century
An early form of fiat currency in the
American Colonies were "bills
of credit".[14]
Provincial governments produced notes which were fiat currency, with the
promise to allow holders to pay taxes in those notes. The notes were
issued to pay current obligations and could be called by levying taxes
at a later time.[14]
Since the notes were denominated in the local unit of account, they
were circulated from person to person in non-tax transactions. These
types of notes were issued particularly in
Pennsylvania,
Virginia and
Massachusetts. Such money was sold at a discount of silver, which
the government would then spend, and would expire at a fixed point in
time later.[14]
Bills of credit have generated some controversy from their inception.
Those who have wanted to highlight the dangers of inflation have focused
on the colonies where the bills of credit depreciated most
dramatically – New England and the Carolinas.[citation
needed] Those who have wanted to defend the use of
bills of credit in the colonies have focused on the middle colonies,
where inflation was practically nonexistent.[14]
Colonial powers consciously introduced fiat currencies backed by
taxes, e.g.
hut taxes
or
poll taxes, to mobilise economic resources in their new possessions,
at least as a transitional arrangement. The repeated cycle of
deflationary hard money, followed by inflationary paper money continued
through much of the 18th and 19th centuries. Often nations would have
dual currencies, with paper trading at some discount to specie backed
money.
Examples include the “Continental”
issued by the
U.S. Congress before the
Constitution; paper versus gold
ducats in
Napoleonic era
Vienna,
where paper often traded at 100:1 against gold; the
South Sea Bubble, which produced bank notes not backed by sufficient
reserves; and the
Mississippi Company scheme of
John Law.
During the
American Civil War, the Federal Government issued
United States Notes, a form of paper fiat currency popularly known
as 'greenbacks'. Their issue was limited by Congress just slightly over
$340 million. During the 1870s, withdrawal of the notes from circulation
was opposed by the
United States Greenback Party. The term 'fiat money' was used in the
resolutions of an 1878 party convention.[15]
20th century
By
World War I most nations had a legalized government monopoly on bank
notes and the legal tender status thereof. In theory, governments still
promised to redeem notes in specie on demand. However, the costs of the
war and the massive expansion afterward made governments suspend
redemption in specie. Since there was no direct penalty for doing so,
governments were not immediately responsible for the economic
consequences of printing more money, which led to
hyperinflation – for example in
Weimar Germany.
Attempts were made to reassert currency stability by anchoring it to
wholesale gold bullion rather than making it payable in specie. This
money combined pure fiat currency, in that the currency was limited to
central bank notes and token coins that were current only by government
fiat, with a form of convertibility, via gold bullion exchange, or via
exchange into US dollars which were convertible into gold bullion, under
the 1945
Bretton Woods system.
Bretton Woods
From 1944 to 1971, the Bretton Woods agreement fixed the value of 35
United States dollars to one
troy ounce of gold.[16]
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. This system collapsed when the United
States government ended the convertibility of the US dollar for gold in
1971, in what became known as the
Nixon Shock.
Chartalism
Chartalism is a monetary theory that states the initial demand for a
fiat currency is generated by its unique ability to extinguish tax
liabilities. Goods and services are traded for fiat money due to the
need to pay taxes in the money.
Loss of backing
A fiat-money currency generally loses value once the issuing
government or central bank refuses to further guarantee its value, but
this need not necessarily occur. For example, the
so-called Swiss dinar continued to retain value in
Kurdish Iraq even after its legal tender status was withdrawn by its
issuer, Iraq's central government.[18]
Monetary economics
In
monetary economics, fiat money is an intrinsically useless product,
used as a means of payment.[19]
In some micro-founded models of money, fiat money is
created internally in a community making feasible trades that would
not otherwise be possible, either because producers and consumers may
not anonymously write
IOUs, or because of physical constraints.[20][21]
See also