Fiat

Fiat money is a type of currency that a government has declared to be legal tender, but it is not backed by a physical commodity. Its value comes not from a pile of gold in a vault, but from the trust and faith people have in the government that issues it. Think of the US dollar, the Euro, or the British pound in your pocket. You can't trade them in for a fixed amount of gold or silver; you accept them as payment because you trust that others will do the same. This system is a relatively recent global experiment, replacing systems like commodity money (where the money itself, like a gold coin, has intrinsic value) and representative money (paper notes that could be redeemed for a set amount of a commodity). The word “fiat” itself comes from Latin, meaning “let it be done” or “it shall be,” perfectly capturing the idea that its value exists simply by government decree.

Unlike money that must be dug out of the ground, fiat money can be created “out of thin air” by a country's central bank. In the United States, this is the Federal Reserve (the Fed); in the Eurozone, it's the European Central Bank (ECB). These institutions can increase the money supply by literally printing more cash, but more commonly, they do it electronically by buying government bonds or other financial assets. This process, known as quantitative easing, injects new money into the banking system, which then flows into the broader economy. This power to create money gives governments immense flexibility to manage economic affairs, but as we'll see, it's a power that comes with significant risks for investors.

For much of modern history, major currencies were tied to gold under a system called the gold standard. This disciplined governments, as they couldn't just print money without having the gold to back it up. However, this rigidity also made it difficult to fight economic downturns. The pivotal moment came in 1971 when U.S. President Richard Nixon officially severed the link between the US dollar and gold. This move, known as the “Nixon Shock,” effectively turned the dollar into a pure fiat currency and, because of the dollar's global importance, pushed the entire world into the fiat system we have today. The main argument for this switch was to give policymakers the tools—specifically, control over the money supply via monetary policy—to stimulate the economy, combat unemployment, and smooth out the volatile ups and downs of the business cycle.

For a value investor, the fiat system presents a classic dilemma. On one hand, the flexibility it offers can prevent deep depressions and create a stable environment for businesses to thrive. On the other hand, it holds a sinister, silent threat: inflation. Because the supply of fiat money is theoretically limitless, there is a constant temptation for governments and central banks to create more of it to pay for spending or stimulate growth. When the supply of money increases faster than the production of actual goods and services, each unit of that currency buys less than it did before. This is the essence of inflation, a hidden tax that erodes the purchasing power of your savings. If a central bank prints too much money, it can lead to hyperinflation, a catastrophic event that wipes out savings and destroys an economy.

This inherent risk of debasement is why many great investors, particularly those influenced by the Austrian School of Economics, are deeply skeptical of holding cash over the long term. They see fiat currency not as a stable store of value, but as a “melting ice cube.” To protect their wealth, they often turn to hard assets. These are tangible assets that have intrinsic value and are difficult to produce more of. Classic examples include:

• Gold and Silver: The ultimate historical hedge against currency failure.
• Real Estate: Land and property are finite and provide utility.
• Wonderful Businesses: This is the preferred hedge of Warren Buffett. A company with strong pricing power—the ability to raise its prices to keep pace with inflation without losing customers (think Coca-Cola or Apple)—is an excellent long-term store of value. Its earnings and dividends will grow with inflation, protecting your purchasing power far better than a savings account.

Understanding fiat money is not just an academic exercise; it’s fundamental to long-term investment survival.

• Be Inflation-Aware: Never forget that the cash in your bank account is likely losing value every single day due to inflation. Your investment returns must consistently beat the rate of inflation to grow your real wealth.
• Think in Terms of Purchasing Power: Don't just count your dollars; consider what those dollars can buy. The goal of investing is to increase your future purchasing power.
• Invest in Scarcity: Seek out assets that are scarce and cannot be easily created by a government decree. This includes high-quality businesses with durable competitive advantages, productive land, and other hard assets.
• Watch the Central Banks: Pay attention to the policies of the Fed and ECB. Their actions directly impact the value of your money and the prices of all your investments.