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Fiat money is a type of currency that is not backed by any commodity such as gold or silver. It is usually designated as legal tender by the issuing government. Throughout history, fiat money has sometimes been issued by local banks and other institutions. In modern times, fiat money is generally authorized by government regulation.
Fiat money generally has no intrinsic value and no utility value. It has value only because the individuals who use it as a unit of account—or, in the case of currency, as a medium of exchange—agree on its value. He believes that merchants and other people will accept it.
Fiat money is an alternative to commodity money, which is a currency that has intrinsic value because it contains, for example, a precious metal such as gold or silver that is embedded in the coin. Fiat is also different from representative money, which is money that has intrinsic value because it is backed and can be converted into precious metal or another commodity. Fiat money may look similar to representative money (such as paper notes), but the former has no backing, while the latter represents a claim on a commodity (which can be repaid to a greater or lesser extent).
Government-issued fiat notes were first used during the 11th century in China. Fiat money came to dominate during the 20th century. Since President Richard Nixon’s decision to suspend the convertibility of the US dollar for gold in 1971, a system of national fiat currencies has been used worldwide.
Fiat money serves as a good currency if it can handle the roles that a national economy needs from its monetary unit – storing value, providing a numerical account, and facilitating exchange. It also has superior seigniorage, meaning it is more cost-effective to produce than a currency tied directly to a commodity.
Fiat currencies gained prominence in the 20th century in part because governments and central banks sought to insulate their economies from the worst effects of natural economic cycle booms and busts.
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