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Fiat Money Explained

Updated on August 21, 2009
Federal Reserve Bank United States image by cliff1066
Federal Reserve Bank United States image by cliff1066

Money is Paper?

That's it, that's all it is... just paper. Money is whatever we agree is money. I could pick up a rock and say that it's worth a burger and fries but unless you agree I won't be able to use the rock to buy lunch.

Our intermediaries (the government) tell us that their money is backed by their reserve system or treasury and that all money has value. We all collectively agree that this paper has value so we use it as a mean of exchange.

But what is money really and why can it be so valuable?

The good old days

The Ancient Egyptians used a form of paper money. People would store their grain in a collective storage bin. Upon arriving a tenant would weigh the grain and provide a ticket accordingly. People quickly realized the value of having these tickets so they used them as a means of trade and purchasing daily goods.

In North America and Europe Gold and Silver were considered valuable. But carrying around the precious metals were dangerous. So they kept the bullion locked up in bank vaults in exchange for tickets that valued their deposits. They too realized that they could use the note rather than the actual gold to buy things. People realized that a note meant hard currency.

Fiat Born

Banks soon realized that people valued notes and not the actual gold so they began printing extra notes to lend out to people buying houses and farms. That way if the loan defaulted they could just reposes the property and resell before anyone would notice that there were more notes than gold deposits.

With money being made in the form of interest banks could no longer hid the fact that they had more in assets than they did in the vault so they helped invent the Fiat Money System.

Governments came on board the Fiat money train because they realized that they could loan way more money than they possibly could before to finance large projects.

With people distracted, the government made their move and established the Federal Reserve Bank to take care of the money supply.

Federal Reserve Bank

The Federal Reserve Bank is not a government institution. What happens is the Government says that they need more money to help the car companies. They go to the Fed and ask for $. The Fed makes the U.S. sign a IOU and then prints the money. The Fed then collects interest on the loan and that just gets piled onto the national debt. The money now is sent to the auto manufacturers and everyone is working and happy. But they soon realise that they have to pay back this loan so at tax time the income tax is all sent to the Fed to pay the minimum interest payments on the national debt they've incurred.

Any questions?

This might help explain things


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    • MTwriter profile image

      MTwriter 7 years ago from Montana

      Nice post, I found it informative and easy to understand. This is a hard topic to break down but I think you made it easy to comprehend.

    • Jyle Dupuis profile image

      Jyle Dupuis 8 years ago from Henrico, Virginia

      Not an easy thing to explain. Sadly they choose never to teach the fundamentals of money in school. So it becomes a confusing subject for the majority of us.

    • James A Watkins profile image

      James A Watkins 8 years ago from Chicago

      Great Hub! This is a fine explication of fiat money. I enjoyed reading it. Thanks!