The value of fiat as a currency is underpinned by the strength of the government issuing it. As it is not backed by any physical goods, it lacks the strength typical of gold or silver currencies.
What is fiat currency?
The value of fiat currency is supported by the confidence the general public has in the central bank and the government of the issuing nation. If a country were to become bankrupt, its fiat currency would lose value significantly.
That’s exactly how fiat money gains its value and acquires its purchasing powers at the same time.
There are different currencies used all over the world in various countries and throughout history as well. These currencies can be classified into two major categories – commodity standard and legal tender.
There’s a longstanding debate regarding which kind of currency is better. Some argue that traditional money is the best choice, while others advocate for the gold standard.
Knowing all the details will help you make a smart choice if you ever need to invest in such currencies.
Production of Fiat Money
This is why paper money is associated with a better economic policy.
Paper money is produced when the government or its financial departments give the signal to print more cash. This is done to strike the right balance of supply and demand for the money in circulation – a balance that can affect the price of goods on the market.
To put it simply, prices will rise when the supply of cash runs low. This can be solved by printing more.
However, recklessly producing lots of paper money can affect its value, and in some instances, render it worthless in the long run. Needless to say, this could potentially harm the economy of a nation as well.
Fiat Money – Example
Since the 1930s, the United States cut its ties with a gold-backed currency as seen under the gold standard. Back then, it was a method of keeping its economy afloat in the middle of a major economic depression.
Other Western countries, especially those that peg their value to the US dollar, followed suit and abandoned the gold standard. Decades later, the rest of the world followed as well, with the US dollar now recognised as the most prominent fiat money within global economies.
Gold Standard vs. Fiat
Gold standard or money backed by physical commodities bases its value on real assets like precious metals. For instance, one unit could cost the same as 1g of gold or 10g of silver.
Any government or entities that wants to use gold-backed currencies need to have a huge gold reserve to back all the currency units they have. Based on the example above, if a government gold reserve only has 1 billion grams of gold, then it could only produce 1 billion units.
Under the gold standard, the value of a country’s currency was directly tied to the amount of gold held by the central bank.
This meant that the amount of money a country could print was limited by the amount of gold it had. These commodities are considered to be more stable stores of value due to their limited supply and long-standing recognition as a medium of exchange.
In contrast, fiat currency is backed only by the government’s promise to pay, which means that central banks have the power to print as much money as they want.
While the gold standard provided stability and limited inflation, the flexibility of fiat currency allows governments to stimulate economic growth by increasing the money supply.
However, this also means that the value of fiat currency is subject to fluctuations and can be impacted by factors like inflation and changes in interest rates.
Fiat Currency vs Gold Standard
Over time, the purchasing power of gold remains stable. As the price of gold increases, it typically offsets the decrease in the value of fiat currencies in relation to the cost of goods and services. Simply put, the price of gold tends to increase by the same amount that consumer prices rise.
The way people talk about the gold market is based on two different things: inflation that keeps going up and the central banks, especially the US Federal Reserve, raising interest rates to try and control it.
The increase or decrease in the value of gold does not necessarily imply a loss of its inherent worth. Instead, it reflects a change in the value of fiat currency, such as the US dollar. The value of gold remains stable, especially during times of economic uncertainty or geopolitical turmoil, as investors tend to turn to it as a safe-haven asset.
For a gold currency to run efficiently, an entity managing it should mine, supply, and store gold efficiently. This often means an undeniably very expensive and difficult undertaking.
This is one of the reasons why most governments don’t simply hop back to gold currencies and choose to stick with using printed money for their economic system.
However, gold has proven to be a superior store of value compared to world reserve currencies:
- The spot gold price hit an all-time high in 2020, crossing $2,067 per troy ounce
- The U.S. dollar has not been able to compete with gold. In nearly 100 years, the U.S. dollar has lost 97% of its value against gold.
- Despite being a relatively young currency, the euro has already lost 85% of its value against gold, with the gold price in euros surging by 555% over the past 20 years, indicating its vulnerability to economic uncertainties.
- Russia and Iran are discussing the launch of a gold-backed cryptocurrency to facilitate bilateral trade deals, as an alternative to using U.S. dollars and bypassing the international banking system.
These stats highlight the instability of fiat currencies. Overall, the past few decades have seen gold retain its value whilst fiat currencies continue to drop.
However, a new kind of asset emerged a few years ago, and it quickly became a worldwide trend that is used in various transactions.
This came in the form of cryptocurrencies, a type of virtual money that initially couldn’t be classified under legal tender or gold.
Stablecoins were also introduced. They are a cryptocurrency designed to prevent the fluctuations in value that other cryptocurrencies, such as Bitcoin, experience by being pegged to the value of a commodity or fiat currency e.g one Tether (USDT) stablecoin is pegged to the value of one dollar.
Nonetheless, they still carry certain risks.
Why is Fiat Different from Cryptocurrency?
Cryptocurrencies have many differences from legal tender, but there is a significant common ground that both share.
Is Bitcoin a fiat currency?
Bitcoin is unlike any other currency you may have encountered before. Unlike fiat currencies, which rely on governments or central authorities to function, Bitcoin is a decentralized digital currency whose value is solely determined by market supply and demand.
It’s easy to compare cryptocurrencies to government-issued money, but in reality, they are vastly different in many ways.
There are 4 key differences between fiat cash and cryptos like Bitcoin.
1. The first is centralization. Governments have full control over fiat currency, while cryptocurrencies operate without any single governing authority. Transactions are tracked on the blockchain, a publicly available, decentralized digital ledger that shows every transaction ever made.
2. The second is that fiat currency can be easily manipulated. Governments can print more money when they need it, flooding the market and devaluing the currency. Cryptocurrencies, on the other hand, have a finite supply that cannot be increased on demand.
3. The value of cryptocurrencies is highly volatile, which makes it risky for investors. In just a short amount of time, the value of a cryptocurrency can skyrocket or plummet, leaving investors caught off-guard. Because of its volatility, many entities are hesitant to accept cryptocurrencies as payment for transactions.
4. Cryptocurrencies can only exist in the digital realm, whereas fiat currency can be both physical cash and digital transactions, making it more accessible for people without digital accounts.
In some countries, the use of cryptocurrencies is illegal, which means that many banks, companies, and governments won’t accept them as payment. However, gold-backed currencies are on the rise, providing innovative solutions to the problems associated with traditional fiat currency.
Gold-backed assets may hold the potential to solve some of the issues associated with traditional money.
What Are The Advantages and Disadvantages of Fiat Money?
Now, you would probably like to know how it is better than the gold standard. Truth be told, both have their own share of pros and cons, with one being better than the other at certain angles.
Advantages of Fiat Currency
When favouring fiat money, one could perceive that the control it can provide to the government is its best advantage. Through the Federal Reserve, it has even proven itself to help the United States to pass through the Great Depression of the early 1900s, helped make its economy steadfast through the decades, and kept the country’s economy from collapsing during the depression of 2007-2009.
- Legal tender could be produced in large quantities, which is a critical tool for solving the demand for more money in economic circulation.
- Fiat doesn’t require demanding resources, cost, and labour to produce – unlike precious metals.
- Government-issued money is also more convenient to distribute and use without too much hassle, especially because it can be used in digital forms.
Still, when using the US dollar as an example, it has helped the country and, eventually, the world in significant ways.
- It aided the US government to cut its ties with the limited gold reserve.
- It has helped the USA to pass through many economic depressions.
- It compelled many European countries to switch to fiat money as well.
- It has stabilised the world economy by making the US dollar a peg for many other national stores of value.
Paper money has made wonders for the US, and eventually the entire world. But fiat has its share of flaws, which brings to the fore the concerns of advocates of the gold standard.
Fiat currency disadvantages
Albeit government-issued, fiat has worked excellently for the US and for the world. Regardless of its benefits, it has its own share of flaws that couldn’t be easily ignored.
- One of the biggest concerns is the diminishing value of any fiat money, which is the main reason why governments keep producing a new generation or new design of currencies every few years. But this could potentially be solved by investing in gold-backed assets like the gold-backed currencies of Kinesis.
- Investing in real gold or in gold-backed assets can help in cushioning your money from the potential value collapse of any legal tender.
- Another relevant flaw of fiat money is the production itself. Although it doesn’t require too many resources to produce, it still needs supplies like printing facilities.
- This begs the question of where the funds for such operations will be sourced? The government and banks can produce fiat
- After producing fiat money, distribution follows. This is done by lending it to individuals, organisations, businesses and even the government. In short, the notes in circulation nowadays likely came from bank loans or debts, giving them the power to initiate an economic problem when the loan is recalled.
Thinking about this kind of collapse would probably push you to find some ways to protect your assets and properties from negative implications. Spread the risk by investing in gold-backed assets as one of the safest and most stable options.
Conclusion on Fiat
Paper money has perceived monetary advantages over gold-backed assets. Specifically, as it gives good economic control to the government. It could help in taming inflation and provide enough supply of cash to the market.
Moreover, fiat money is easier to distribute and use in daily transactions. It’s not that heavy compared to gold coins, and could exist both in physical and digital form.
On the other hand, while the relatively easier production process of fiat money makes it a good asset for the government, the ability to print money out of thin air has consequences.
In addition, the diminishing value of fiat, along with some other problems surrounding it, should not be underestimated. As it is easy to control, some other entities could also manipulate its circulation – which could lead to an economic disaster.
That is why, despite fiat being better than gold in many ways, it is still important to invest in gold to help in cushioning your assets in case of unfavourable economic conditions.
How to Invest in Gold
In the current age of technology, the answer to this question is placed on the blockchain. Digitalising gold and silver revolutionises investing in gold online.
With the looming possibility of traditional money failing, bespoke blockchain technology has been created. Kinesis, an innovative monetary platform, is designed to make investing in gold much easier and far more efficient.
Making gold run on the blockchain, makes the asset available for everyone.
Since gold has a stable value throughout the years, you can expect it to help cushion you in the event of a dollar crash. The availability of it in the blockchain results in a far more convenient way of using gold as a tool for value transactions.
To sum up, while fiat is taking the current economic control, gold-backed assets could help you secure a good future ahead. This makes it important to know about the monetary advantages of both, so you can maximise their value to your benefit.
This publication is for informational purposes only and is not intended to be a solicitation, offering or recommendation of any security, commodity, derivative, investment management service or advisory service and is not commodity trading advice. This publication does not intend to provide investment, tax or legal advice on either a general or specific basis.