Money is by far the most widely used human invention. And it is that when we believe it, practically all aspects of our life are governed based on this same, from food to health require money. But before I can establish what it is Fiat money, which is the main topic of this post, you must answer two questions: What is money? And above all, how do we know the value of money?
What is money
To set money in a simple way we can use the following definition: money is any asset, or also a good, that is valid as a means of payment to be able to carry out the exchange of goods. In other words, it is everything we use to buy something; in such a way that not only the coins and bills are valid as money, but also electronic transfers or debit cards. But what makes money valid? Why can't any person or institution print tickets or use cards?
So that the economic system it can remain stable, it is necessary that there is an issuing entity that supports the value of said money. Currently the entities that are in charge of having this role are governments, and the way they regulate the validity of money is through current law. So we have already located a first one involved in the creation and valuation of money, but even though the government regulates and supports the existing money, does it issue it?
The solution to the previous question is no, since banks are the entities in charge of various aspects of money, let's see what they are. The first thing that central banks and mints take care of is the regulation and also the control of the monetary policy that remains in force and that makes it possible to keep money under constant surveillance and control. Second, these entities are also responsible for creating the physical representations of money, such as bills or debit cards.
How do we know the value of money?
Now that we know what money is, let's take a look at its history to find out what establishes money. value of a coin or bill, to later be able to establish Fiat money. At the beginning of human history, when there was no money, we exchanged, in other words, we exchanged a product that we had, for one that we wanted or needed. But this system was not very efficient since there was no point of reference that evaluated all possessions objectively, but the value of things is offered by the negotiating capacity of the person.
Later the value of things was standardized making use of precious metals; The reason for this is that these metals were themselves a benchmark when people valued them. At the same time, they offered the advantage of being limited, in such a way that it was easy to control people's purchasing power, since not everyone could create a gold or silver coin. And even though the value of these materials has not decreased, it is interesting that we noticed that someone came to replace it, the well-known paper money.
It is at this point where our question is answered, and it is that the value of paper money is defined by the precious metal reserves of the government that issues the banknotes. And to date, this system is still in force, since central entities continue to maintain their precious metal reserves.
Now that we have understood the above, that money is the medium of exchange, and that its value is given by the support offered by a central entity, we can go on to establish the Fiat money.
What is fiat money?
This type of money is also known as fiat money, and it is money (medium of exchange) that gets the value, not from the backing of the reserves of a financial institution, but on the basis of the faith or trust that the community has. Although it may seem strange, the truth is that it is the monetary system that predominates today throughout the world. But its origin is not current.
Fiat money began to be used in China, and it was in 1971 that the era when precious metals defined the value of money can be ended; It was then that the Bretton Woods agreements broke with the system that supported the price of the dollar, through precious metals.
Now, this makes a lot of sense in what we live today; and the clearest example that we can see is the value of the euro in terms of other currencies. To explain the matter a bit, if governments still backed the value of money with precious metals, currencies would always be held at a constant value. It is when fiat money is born that it begins to congratulate a series of currencies that, instead of basing their value on a guarantee, base their value on the link that exists between a currency in terms of the others that exist.
It is at this point where we can already explain that there is two types of money, merchant money that it has its value on the basis of having a counterpart like precious metals; and fiat money, which has a value before the people and before the rest of the governments, based on the declaration of the issuing government. And in order to summarize this in simpler terms, we can mention that the euro has value because, in this case, a series of governments have agreed to give validity to this currency; so that when a government does not declare that a currency is legal, it will not be valid as a currency, in other words, we will not be able to change it, or buy anything.
Fiat money
The European central bank, which is the one that has declared that the euro is valid and accepted as currency, establishes the fiduciary currency as the one that is defined through the imposition of some government legislation that aims to orient the trade and economy of the governed place towards a medium Defined exchange rate, this is whether you prefer the dollar or the euro or the yen.
Now that we know what it is Fiat money, we can move on to another point of great interest and that is how we use fiat money, as well as what tools are made available to us to facilitate the manipulation of this asset.
Tools for fiat money
Previously, when gold was the basis of the economy and it was the one that establishes the value of each monetary unit with respect to the gold support that existed in banks, the way in which transactions were carried out, or purchases, was through the definition of a fixed value to the coin, so we knew that a 20-coin bill was backed by enough value to be able to buy 20 pencils, and if someone tried to buy those pencils using another currency or other type of asset, basically no it was valid as a purchase, but rather as a barter.
However, with the arrival of Fiat money Tools are emerging that allow us to exchange products without the need for a ticket or physical currency that were previously essential. Some of these tools are checks; These checks can look like nothing more than a sheet of paper with a legend indicating a number. However, when this paper is supported by the financial institution it becomes money, by definition a means of making purchases.
Another tool we have to be able The control of the fiat money is the promissory notes. When we make a sale, but our buyer does not have the necessary money to make the purchase, we can use a promissory note, which is a legal document that guarantees us as sellers, that the buyer agrees to pay the amount stipulated in it. document. . So when we pay attention to these types of documents we realize that what we are receiving is money, money that has a value based on the confidence we have that said person will make the payment. It is for this reason that promissory notes are documents that can be transferred, in such a way that when we do not have paper money, we can make the purchase of something using the promissory note.
On the other hand, we can find the rest of legal documents that are of a monetary aspect, such as bank accounts, in which we do not have a paper money that proves that our money is real; Rather, the person or institution gives us a purely legal endorsement that this money exists and is valid for when we make the decision to enforce.
Undoubtedly, knowing the behavior and history of fiat money will help us a lot to better understand how the economic and monetary system works in the vast majority of countries that made the decision to switch to fiat money.
