FIAT MONEY

Fiat money is any money whose value is determined by legal means, rather than the strict availability of goods and services which are named on the representative note. For differentiation examples, a "gold certificate" would be a kind of representative money, and a banknote from a well-trusted bank which is not a central or government-backed bank (such as the Bank of Scotland) would be a kind of credit money. Fiat money is created when a type of credit money (typically notes from a central bank, such as the Federal Reserve System in the U.S.) is declared by a government act (fiat) to be acceptable and officially-recognized payment for all debts, both public and private. Fiat money may thus be symbolic of a commodity or a government promise, though not a completely specified amount of either of these. Fiat money is thus not technically fungable or tradable directly for fixed quantities of anything, except more of the same government's fiat money. Fiat moneys trade against each other in value in an international market, as with other goods. Many fiat moneys accepted on the international market has having value (which not all fiat moneys are) thus trade indirectly against any internationally available goods and services. Thus the number of U.S. dollars or Japanese yen which are equivalent to each other, or to a gram of gold metal, are all market decisions which change from moment to moment on a daily basis.

Representative, credit, and fiat money all provide solutions to several limitations of commodity money. Depending on the laws, there may be little or no need to physically transport the money — an electronic exchange may be sufficient. Other types of moneys have as their sole use to be medium of exchange, so their supply is not limited by competing alternate uses. Credit and fiat monies can be created without limit in theory, so there is no limit on trade volumes.

Fiat money, if physically represented in the form of currency (paper or coins) can be easily damaged or destroyed. However, here fiat money has an advantage over representative or commodity money, in that the same laws that created the money can also define rules for its replacement in case of damage or destruction. For example, the U.S. government will replace mutilated federal reserve notes (U.S. fiat money) if at least half of the physical note can be reconstructed, or if it can be otherwise proven to have been destroyed. By contrast, commodity money which has been destroyed or lost, is gone.

Paper currency is especially vulnerable to everyday hazards: from fire, water, termites, and simple wear and tear. Currency in the form of minted coins is more durable but a significant portion is simply lost in everyday use. In order to reduce replacement costs, many countries are converting to plastic currency. For example, Mexico has changed its twenty and fifty peso notes, Singapore its $2, $5, $10 and $50 bills, Malaysia with RM5 bill, and Australia and New Zealand their $5, $10, $20, $50 and $100 to plastic, both for the increased durability and because plastic may be easily specifically constructed for each denomination, thus making it impossible for counterfeiters to "lift" or raise the value of a bill by using the material of a bill of lesser value as a primary source to make a counterfeit note of higher value.

Some of the benefits of fiat money can be a double-edged sword. For example, if the amount of money in active circulation outstrips the available goods and services for sale, the effect can be inflationary. This can easily happen if governments print money without attention to the level of economic activity, or if successful counterfeiters flourish.

A criticism of credit and fiat moneys relates to the fact that their stabilities are highly dependent on the stability of the legal system backing the currency: should the legal system fail, so will the value of any type of money that depends on it. However, this situation is typical of the maintainance of the value of any promisory note system: if a guarantor creates money or wealth by means of any legal promise to provide goods or services in the future (as is the case with both credit and fiat type moneys), then any failure of a legal system which backs up the rights of the debt-holder to collect on the promise, will act to jeoparize the value of future promises.