Show pageOld revisionsBacklinksBack to top This page is read only. You can view the source, but not change it. Ask your administrator if you think this is wrong. ====== Fiat Money ====== Fiat money is government-issued currency that is not backed by a physical commodity, such as gold or silver. Instead, its value is derived from the trust and confidence people have in the government that issues it and its declaration as [[legal tender]]. The term "fiat" comes from the Latin for "let it be done," reflecting the fact that this money has value simply by government order or decree. Unlike [[commodity money]], which has [[intrinsic value]] (a gold coin is valuable for the gold itself), a dollar bill or a euro note has no value other than its use as a medium of exchange. All major modern economies, including the United States and the Eurozone, operate on a fiat money system, managed by their respective [[central bank]]. This system provides governments with greater flexibility to manage economic challenges, but it also places the currency's stability and [[purchasing power]] entirely in the hands of its human managers. ===== How Fiat Money Works ===== ==== The Power of a Promise ==== At its heart, fiat money operates on a collective social agreement. It works because you believe you can exchange your paper money for goods and services, and the seller believes the same thing. This belief is anchored by the government's decree that the currency must be accepted for all debts, public and private. However, this promise is only as good as the institution backing it. The value of fiat money rests on the perceived stability of the issuing government and the prudent management of the money supply by its central bank, such as the [[Federal Reserve]] (the Fed) in the U.S. or the [[European Central Bank]] (ECB) in the Eurozone. ==== The Central Bank's Role ==== Central banks are the stewards of a nation's fiat currency. They wield a powerful tool called [[monetary policy]] to influence the economy. By controlling interest rates and the amount of money in circulation, they aim to: * **Control Inflation:** Keep prices stable and prevent the currency from losing value too quickly. * **Maximize Employment:** Encourage economic growth and job creation. This gives policymakers the flexibility to respond to economic crises by, for example, increasing the money supply to stimulate demand. But this power is a double-edged sword. If mismanaged, it can lead to devastating consequences for savers and investors. ===== Fiat Money for the Value Investor ===== For a //value investor//, understanding the nature of fiat money isn't just an academic exercise—it's the foundation of a sound long-term strategy. ==== The Great Enemy: Inflation ==== The single greatest danger of a fiat system is the persistent temptation for governments and central banks to create more money out of thin air. This can be done to finance government spending, pay down national debt, or bail out struggling industries. When the money supply grows faster than the actual economic output of goods and services, the value of each individual currency unit falls. This is [[inflation]]. Inflation is a silent tax on your savings. A 3% inflation rate means that the €100 you hide under your mattress will only buy €97 worth of goods in a year's time. In extreme cases, a loss of confidence can lead to [[hyperinflation]], where a currency becomes virtually worthless overnight. Modern policies like [[quantitative easing]] (QE) are essentially sophisticated, large-scale versions of money creation, making the threat of currency debasement a permanent feature of the investment landscape. ==== So, What's an Investor to Do? ==== The most important takeaway for an investor is this: **In a fiat money system, holding large amounts of cash over the long term is a losing strategy.** The primary goal of investing is to convert your depreciating cash into assets that can preserve and grow their real value over time. A value investor seeks to own productive assets that can outpace inflation. These include: * **Great Businesses (Stocks):** A wonderful business with a strong competitive advantage can raise its prices to offset rising costs, thereby protecting its profitability and, by extension, your investment. * **Productive Real Estate:** Properties that generate rental income, which can often be adjusted for inflation, provide a hedge while the underlying asset appreciates. * **Durable Commodities (with caution):** While they don't produce cash flow, some investors hold assets like gold as a form of insurance against severe currency debasement or systemic financial risk. ===== A Brief History: From Gold to Fiat ===== For most of history, money was tied to something tangible. Under a [[gold standard]], you could, in theory, walk into a bank and exchange your paper currency for a fixed amount of physical gold. After World War II, the [[Bretton Woods system]] pegged most global currencies to the U.S. dollar, which itself was convertible to gold. This all changed in 1971. In what became known as the "Nixon Shock," U.S. President Richard Nixon formally ended the direct convertibility of the U.S. dollar to gold. With that act, the world's reserve currency was untethered from any physical commodity, and the global financial system entered the modern fiat era. ===== The Bottom Line ===== Fiat money is a powerful tool for economic management, but it carries the inherent risk of debasement through inflation. For the prudent investor, this reality transforms investing from a choice into a necessity. The goal is not merely to accumulate more dollars or euros, but to own a piece of the real, productive economy whose value can endure long after the purchasing power of today's cash has faded.