Fiat Money
BeginnerFiat money is currency that a government has declared to be legal tender but that is not backed by a physical commodity, such as gold or silver, with its value coming from trust in the issuing government and central bank.
The word fiat comes from Latin, meaning let it be done, reflecting that the money has value because the government declares it so.
Almost all modern currencies, including the US dollar, euro, British pound, Japanese yen, Indian rupee, Canadian dollar and Australian dollar, are fiat currencies. Their value depends on people’s confidence that they will be accepted for goods, services and taxes, and on the central bank’s ability to keep inflation under control.
Before fiat money became standard, many currencies were linked to gold. Under the Bretton Woods system after the Second World War, other currencies were pegged to the US dollar, which was convertible into gold for foreign governments. In 1971, the United States ended the dollar’s convertibility into gold, and by the mid-1970s the major currencies had become purely fiat.
For example, a banknote is valuable because people trust that others will accept it, not because it can be exchanged for gold.
Fiat money allows central banks to adjust the money supply to respond to economic conditions. Critics argue it can lead to inflation if governments create too much money, as has happened in hyperinflations.
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