The Greeks was the first society to be transformed by money. Here are just few examples how money transformed the world.
- Cities like Athens which had a strong currency, grew and democracy flourished.
- Kings could now afford armies and that with it came more wars.
- Economist emerged.
- Marriage became a business, dowries, bride prices, divorce settlements were now considered when matches made.
The definition of money has varied. For centuries, physical commodities, most commonly silver or gold, served as money. Later, when paper money and checkable deposits were introduced, they were convertible into commodity money. The abandonment of convertibility of money into a commodity since August 15, 1971, when the U.S President Richard M. Nixon discontinued converting U.S. dollars into gold at $35 per ounce, has made the monies of the United States and other countries into fiat money—money that national monetary authorities have the power to issue without legal constraints.
The global monetary system is what’s called a Fiat system in meaning and is accepted as money because a government says that it’s legal tender, and the public has enough confidence and faith in the money’s ability to serve as a storage medium for purchasing powerThe value of fiat money depends on supply and demand and was introduced as an alternative to commodity money and representative money.
A Little History of FIAT Money
Fiat money originated from China in the 10th century, mainly in the Yuan, Tang, Song, and Ming dynasties. In the Tang Dynasty (618-907), there was a high demand for metallic currency that exceeded the supply of precious metals. The people were familiar with the use of credit notes, and they readily accepted pieces of paper or paper drafts.
A shortage of coins forced people to change from coins to notes. During the Song Dynasty (960-1276), there was a booming business in the Tchetchuan region that led to a shortage of copper money. Traders started issuing private notes covered by a monetary reserve, and it was considered to be the first legal tender. Paper money became the only legal tender in the Yuan Dynasty (1276-1367), and issuing of notes was conferred to the Ministry of Finance during the Ming Dynasty (1368-1644).
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Fiat money was also used in Europe during the 17th century, being adopted by Spain, Sweden, and the Netherlands. The system was a failure in Sweden and the government eventually abandoned it for the silver standard. Over the next two centuries, New France in Canada, the American Colonies, and then the U.S. Federal Government also experimented with fiat money with mixed results.
Before Fiat Money
At the beginning of the 20th century, U.S. had a bimetal standard with both silver and gold forming the basis for the U.S. dollar.It was during that year that the U.S, Congress passed the Gold Standard Act which set the value of the dollar based on 1.5 grams of gold. In theory, every paper dollar could be redeemed for an equivalent value in gold.
The gold standard limited the government’s ability to print money and handle debt because the amount of paper money in circulation had to equal the federal gold reserves.When the Federal Reserve Act was passed in 1913, the amount of gold backing each dollar was reduced to just 40% of the face value of existing currency.
Keeping to to the gold standard first became a problem during World War I when the government needed to print more money to handle the expenses of war. The gold standard was actually suspended twice during World War I.
During the Great depression, every major currency around the globe abandoned the Gold Standard as people began to hoard gold and demand that the Treasury exchange their paper money for gold. In 1933, the federal government suspended the gold standard once again, and Congress banned the private ownership of significant amounts of gold and in 1934 brought the Gold Reserve Act which allowed the government to decide the amount of gold a paper dollar represented and to nationalize its stores of gold bullion.
The same year, the U.S. government devalued the dollar by 41% by raising the price of gold from $20.67 per ounce—the price established way back in 1834—to $35. This revaluation of the dollar raised the value of the gold held at the U.S. Treasury, so that it once again matched the total value of base money, or all the dollars then in circulation. In effect, the U.S. dollar was once again fully backed by gold, but the dollar for dollar relationship was gone. Where in 1900, a paper dollar represented a dollar’s worth of gold, that was no longer true. More dollars were printed than the gold available to back them.
The Bretton Woods Agreement
It was clear during the Second World War that a new international system would be needed to replace the gold standard after the war ended.
In July 1944 about 730 delegates representing 44 countries met in Bretton Woods with the principal goals of creating an efficient foreign exchange system, preventing competitive devaluations of currencies, and promoting international economic growth. The Bretton Woods Agreement and System were central to these goals.
During the era of the Bretton Woods system, the world economy grew rapidly. Keynesian economic policies enabled governments to dampen economic fluctuations, and recessions were generally minor.
Following World War II, U.S. economic interests became more multinational, as world markets emerged and as the U.S. took centre stage in international politics. Pressures on the gold standard increased to the point where the system became unworkable. In 1963, the words “payable to the bearer on demand” were removed from all newly issued Federal Reserve notes. As of 1968, you could no longer redeem pre-1963 notes for silver or gold. The Coinage Act of 1965 removed all silver from quarters and dimes. (Earlier dimes were 90% silver).
The gold standard had established the price of gold at $35.00 per ounce. However, gold was trading at higher prices in foreign markets, so in 1971, the U.S. stopped selling gold to foreign investors who wanted to trade their U.S. dollars for gold. In 1973, the U.S. devalued the dollar, but circumstances forced a second devaluation only 2 weeks later. It was clear to everyone in finance and government that there simply was not enough gold to back the amount of currency needed to maintain economic growth. In 1974, President Ford repealed the prohibition on the public’s ability to own gold. By then, the Gold Standard was over. Our currency was no longer backed by gold. Finally, in 1976, the government made it official. The definition of the dollar in terms of gold was removed from the statute. Our monetary system became one of pure fiat money.
The creation of Bretton Woods resulted in countries pegging their currencies to the U.S. dollar. In turn, the dollar was pegged to the price of gold, and the U.S. became dominant in the world economy. The U.S. was the only nation that could print the globally accepted currency, and countries had more flexibility than they did with the old gold standard.
When the dollar ceased to be pegged to the price of gold, it became the monetary standard with other currencies pegging their currencies to it.
Fiat Money vs. The Gold Standard
The gold standard system permitted the conversion of paper bills to gold.. Under a commodity-based currency system, governments and banks could only introduce new currency into the economy if they held an equal amount in value of gold stores. This system limited the government’s ability to create money and to increase the value of their currency based solely on economic factors.
Under the fiat currency system, money may not be converted to anything else. With fiat money, authorities can directly impact the value of their currency and tie it to economic conditions. Governments and their countries’ central banks have far more control of currency systems. They can respond to varying financial events and crises with different tools, like the creation of fractional reserve banking and the implementation of quantitative easing.
Some Pros and Cons of Using Fiat Currency
Economists and other financial experts are not unanimous in their support of fiat currency. Defenders and opposers passionately argue the pros and cons of this currency system: Historically, the implementation of fiat currency systems has typically led to financial collapses, which indicates that these systems present some risks.
Fiat money is not impacted and limited by the scarcity of a physical commodity like gold. Fiat money is more affordable to produce than commodity-based money. Fiat currency gives governments and their central banks the flexibility to address economic crises.
Fiat currency is used in nations around the world, making it an acceptable form of currency for international trade.Unlike gold, fiat money is not reliant on physical reserves that require storage, protection, monitoring, and other costly demands.
Fiat currency holds no intrinsic value. This allows governments to create money from nothing, which could lead to hyperinflation and collapse their economic system.
Future of Money
Digital currency is gaining acceptance. Many countries are moving in the direction of digital payments. Although it may sound futuristic to live in a world without physical money, it’s not too hard to believe considering the ease and convenience of digital payment systems.
Some developed economies are embracing a no-cash lifestyle faster than others. Sweden use digital transactions for 98 percent of the country’s commerce.
