What Does Fiat Money Mean?

A fiat money is a medium of exchange composed of some intrinsically valueless substance which the issuer does not promise to redeem in a commodity or a fiduciary money.

Because a fiat money has no direct legal connection to a commodity money (in terms of redemption) and, therefore, no real economic cost to its production, the supply of a fiat money can never be self-limiting; and the value of a fiat money is always largely a matter of public confidence in the economic or political stability of the issuer.

Historically every major fiat money have self-destructed in what is popularly called “hyperinflation” (that is, extreme decreases in purchasing-power) caused by either unlimited increases in the supply of that fiat money by the issuer or accelerating loss of public confidence in the continued value of the money or the economic or political fortunes of its issuer, or both.

The theory and history of fiduciary money (which is also largely the theory and history of banking) must always focus on the ever-present problem of redemption. Emphasis on the noun “problem” is warranted, because a fiduciary money is, by definition, a promise to pay the real, commodity money of the country.

A piece of commodity money – typically, a silver or gold coin – is itself payment because it contains a fixed weight of precious metal. But a unit of fiduciary money – typically, a bank or government-treasury note – is only a contingent and uncertain payment that depends upon the ability or the willingness of the issuer to redeem. And there always exists a temptation for issuers to renege on their promises to redeem.

Thus, fiduciary money always threatens to become fraudulent money. Not surprisingly, therefore, the history of fiduciary money has been more or less the history of monetary fraud, both economic and political.

Also, the danger of fraud in the issuance of fiduciary money becomes particularly acute in the case of modern “fractional-reserve banking”.

Under fractional-reserve banking, the bank always issues more units of fiduciary money, supposedly “payable on demand”, than it has units of commodity money available for redemption, counting on the unlikelihood that the majority of its customers will ever seek redemption at one time. Thus, modern fractional-reserve banking is inherently fraudulent, because:

For the bank simultaneously to fulfill all its promises to redeem its outstanding notes “on demand” is impossible.

The bank’s managers know that complete redemption “on demand” is impossible, and therefore that the bank’s promises to pay are false. And,

The bank’s customers, by and large, are ignorant of how the fractional-reserve scheme works, and the dangers it poses to them.

So I believe it is doomed to fail just like every other time…

What is the solution? To store your wealth in something that is not being rapidly devalued, such as gold or silver.