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As of now in 2022, the United States is experiencing inflation for a variety of different reasons.
One reason is the demand for certain products due to COVID-19. The other is the Russian invasion of Ukraine which has caused gas prices to surge.
While inflation can be good or bad, consumers are victims of most of the bad effects happening now.
How does this affect fiat currencies? What are fiat currencies exactly? Keep reading to have your questions answered.
What Are Fiat Currencies?
Fiat currencies, or fiat money, are government-issued and not backed by a physical commodity.
So, what are fiat currencies valued at? The value of fiat currency depends on supply and demand and the stability of the government that issued the money.
Almost all modern paper currencies are fiat currencies. This includes the U.S. dollar and the euro. Fiat currencies only have value because the government maintains them.
Because fiat money is not backed by commodities, such as gold or silver bars, it risks losing value during inflation and hyperinflation.
Fiat Money in the United States
One of the most common examples of fiat currency is the U.S. dollar. It is considered fiat money and legal tender. Legal tender refers to any currency that a government declares legal.
Most governments issue a fiat currency and make it a legal tender by making it the standard for debt repayment.
U.S. dollars are legal tender, not lawful money. This fiat currency can be exchanged for gold, silver, and even crypto commodities. For example, you can buy fantom using U.S. dollars.
Pros of Fiat Money
Fiat national currency can handle the roles that an economy needs in a monetary unit. It can store value, facilitate exchanges, and provides numerical accounts.
It’s more cost-efficient to produce this money rather than a currency that is tied to a physical commodity.
Central banks have control over the supply of fiat currencies. They have the power to manage the following variables:
- Credit supply
- Interest rates
- Money velocity
An example of this would be the U.S. Federal Reserve creating the dual mandate to keep inflation and unemployment low.
Cons of Fiat Money
There are three main cons of fiat money. One we already mentioned is inflation. The risk of inflation and crises isn’t always preventable by the government and central banks.
Regulating the money supply isn’t enough to prevent serious recessions or depressions. This results in the second con of fiat money: it’s not a fool-proof way to protect the economy.
In general, a currency tied to gold or another commodity is more stable because of its limited supply. The third con of fiat money is that there is an opportunity for a bubble because of its unlimited supply.
Understanding Fiat Currencies
Understanding fiat currencies is important in times of inflation and hyperinflation. So, what are fiat currencies? They are government-issued and not backed by a commodity.
You’ll get a better idea of the economy you are living in and how it affects your money by knowing about fiat currencies.
Having a strong and stable currency is a mandate for modern central banks. Obtaining financing and trading is not possible with a devalued currency.
For more articles that can teach you something new, check out the other posts on our blog!