Fiat Money

Fiat Money is any currency declared by a country’s money to be legal tender but these currency aren’t backed by any physical commodity and nor the material it is made up of has any significant value.The currency has the stated value because the Government says that the currency has the stated value.The word “fiat” comes from Latin which means “it shall be”.A fiat money maintains its value in the international market based upon its demand,the Government’s stability and political conditions.

All the currency present in the world are fiat money both paper notes and coins.however, in the past the currencies issued by banks and government were representative currency which were backed by commodity of  great value which usually were gold or silver.In representative currency each unit of currency were backed by a equivalent amount of gold or silver and people would walk up to a bank ,demand that they wanted the equivalent amount of gold backed by the currency and they could receive it.Theoretically a Government could only issue currency that was equivalent to the government’s holding of  gold and silver in it’s vault. Until 1971 the currency  was convertible but after that in the USA it became non-convertible and the rest of governments did the same gradually.

After adoption of fiat currency model many Government’s issued a very huge amount of money according to their requirements.There are many instances where due to increased money supply the economy went through a hyperinflation which saw extreme inflation rates compared to previous system.The hyperinflation is caused by an excessive growth of money supply.A low and steady rate of inflation is preferable rather than hyperinflation. A steady money supply growth may instead lead to stable prices at a time rather than the prices increasing too much.

The task of keeping the rate of inflation rate low and stable is usually given to monetary authorities and the central banks use various tools such as SLR,CRR ,REPO and Reverse REPO to comtrol the money flow.

The major reason that Government Bonds or debentures are really safe is because the Government can always issue more notes and repay the debt.Actually they are creating a inflationary situation and paying their debt but their is no guarantee what the buying power of these currency might be at that time.

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