A central bank introduces new money into an economy by buying financial assets or lending money to financial institutions. Commercial banks then reallocate or use this monetary base through credit creation by fractional reserve banks, thereby expanding the overall supply of “broad money” (cash plus demand deposits). [ref. needed] However, this does not necessarily have to happen, especially if a currency remains the most readily available; For example, before 1990, the Iraqi dinar retained its value in the Kurdistan Regional Government even after its legal tender was terminated by the Iraqi government issuing the banknotes. [39] [40] Fiat currencies give central banks more control over the economy. Most of the currencies used today are fiat currency. For example, dollars. Washington Irving reports an emergency use of paper money by the Spanish for a siege during the conquest of Granada (1482-1492). In 1661, Johan Palmstruch issued the first regular paper money in the West, by royal charter of the Kingdom of Sweden, by a new institution, the Stockholm Bank. While this private paper currency was largely a failure, the Swedish parliament eventually took control of the issuance of paper money in the country. By 1745, his paper money was no longer convertible into cash, but its acceptance was mandated by the government.
[18] This fiat currency depreciated so rapidly that it returned to a silver standard in 1776. Fiat money also has other beginnings in 17th century Europe after its introduction by the Bank of Amsterdam in 1683. [19] The Song Dynasty in China was the first to issue paper money, Jiaozi, around the 10th century AD. Although banknotes were valued at a certain exchange rate for gold, silver or silk, in practice conversion was never allowed. Tickets were originally supposed to be redeemed after three years and replaced with new tickets for a 3% service fee, but as more of them were printed without the tickets being withdrawn, inflation became apparent. The government made several attempts to preserve the value of paper money by charging taxes partly in money and enacting other laws, but the damage was done and banknotes became unfavorable. [15] As the French government`s financial situation deteriorated as a result of the European wars, it reduced its financial support for its colonies, so that Canada`s colonial authorities became increasingly dependent on card money. By 1757, the government had ceased all payments in coins and payments were made in paper form instead. In an application of Gresham`s Law – bad money drives out good – people hoarded gold and silver and used paper money instead. The cost of the Seven Years` War led to rapid inflation in New France.
After the British conquest in 1760, paper money became almost worthless, but the agreement did not end as gold and silver that had been hoarded returned to circulation. By the Treaty of Paris (1763), the French government agreed to convert card money into circulation, but since the French government was essentially bankrupt, these bonds had defaulted and, by 1771, they were no longer valuable. Cryptocurrencies are not considered money (i.e. accepted for use) in most parts of the world because there is no legal tender. However, El Salvador was the first country in the world to accept Bitcoin as legal tender in June 2021. The advantage of fiat money is that it gives central banks greater control over the economy because they can control the amount of money printed. Inflation can occur when a government creates too much fiat money and the money supply grows too quickly as a result. Governments that print too much money can cause hyperinflation. In the 13th century, Marco Polo described the fiat currency of the Yuan dynasty in his book The Travels of Marco Polo. [16] [17] What is legal tender? What is “fiat money”? Fiat money loses a lot of value when the issuing government or central bank loses capacity or refuses to continue to guarantee its value.
The usual consequence is hyperinflation. Some examples include the Zimbabwe dollar, the currency of China in 1945 and the mark of the Weimar Republic in 1923. A more recent example is the monetary instability in Venezuela, which began in 2016 during the ongoing socio-economic and political crisis in the country. Fiat money is a currency (medium of exchange) that has been established as money, often through government regulation, that has no intrinsic value. Fiat money has no use value (inherent benefit, like a cowhide or beaver skin) and has value only because a government maintains its value or because the parties involved in the exchange agree on its value. [1] It was introduced as an alternative to commodity money (a medium that has its own intrinsic value) and representative money (money that represents something that has intrinsic value). Representative money is similar to fiat money, but represents a claim on a commodity (which can be more or less redeemed). [2] [3] [a] The following Yuan dynasty was the first dynasty in China to use paper money as the dominant means of circulation. The founder of the Yuan dynasty, Kublai Khan, issued paper money known as Jiaochao during his reign. Original banknotes during the Yuan Dynasty were limited in area and duration as in the Song Dynasty. China has a long history with paper money, starting in the 7th century.
During the 11th century, the government established a monopoly on their spending, and towards the end of the 12th century, convertibility was suspended. [13] The use of this money became widespread during the following Yuan and Ming dynasties. [14] The value of the dollar fluctuates with economic conditions and the federal government`s interest rate management.