Fiat Money

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DEFINITION of 'Fiat Money'

Currency that a government has declared to be legal tender, but is not backed by a physical commodity. The value of fiat money is derived from the relationship between supply and demand rather than the value of the material that the money is made of. Historically, most currencies were based on physical commodities such as gold or silver, but fiat money is based solely on faith. Fiat is the Latin word for "it shall be".

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BREAKING DOWN 'Fiat Money'

Because fiat money is not linked to physical reserves, it risks becoming worthless due to hyperinflation. If people lose faith in a nation's paper currency, like the dollar bill, the money will no longer hold any value.

Most modern paper currencies are fiat currencies, have no intrinsic value and are used solely as a means of payment. Historically, governments would mint coins out of a physical commodity such as gold or silver, or would print paper money that could be redeemed for a set amount of physical commodity. Fiat money is inconvertible and cannot be redeemed. Fiat money rose to prominence in the 20th century, specifically after the collapse of the Bretton Woods system in 1971, when the United States ceased to allow the conversion of the dollar into gold. 

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RELATED FAQS
  1. Is credit a form of fiat money?

    To understand why credit is a form of fiat money, one must first understand what money is. At its most basic level, money ... Read Full Answer >>
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    Fiat money is physical money (paper money and coins), while representative money is something that represents intent to pay ... Read Full Answer >>
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    Fiat money does not have any intrinsic value. What value it has depends on public confidence in the currency's issuer. Legal ... Read Full Answer >>
  4. Is fiat money more prone to inflation than commodity money?

    The value of fiat money is based largely on public faith in the issuer. Commodity money's value is based on the material ... Read Full Answer >>
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