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Fiat (Paper) Money

Fiat money is money that has nothing of substance behind it. According to Webster's New World Dictionary, fiat money is “currency made legal tender by fiat (sanction) and neither backed by, nor necessarily convertible into, gold or silver.” It is a promise to repay nothing, over an unspecified period. This inconvertible paper currency system gives the central bank the power to issue and circulate paper money, which has no intrinsic value except the full faith and credit of the government of a country that has an economic base to rely on. The government adds its full faith and credit to the currency so its citizens and other governments in the world will accept it. This concept of fiat money also allows the government to create (print and/or mint) new money at will to pay off government debts, pay government employees, and use the printed money for any other government expenditure.

The first to introduce the idea of offering money at a less-than-pure gold or silver base were the kings of England, who introduced an idea they branded as the debasement of money. Debasement is the lowering of the precious metal content of the currency. Debasements were achieved by recoinage. In England during the twelfth century, one pound of silver was minted into 240 silver pennies; during 1666, one pound of silver was minted into some 700 silver pennies, a decline in the value content of almost 292 percent. By means of their debasements, the kings had created what is known today as fiat money. Fiat money is a token of value — its intrinsic value is less than its exchange value. Its exchange value is given to it by fiat (order) of the king or the government involved.

Today, precious metal coins are no longer used, and the world deals only with fiat money. The early English bankers produced something of no value (a piece of paper) and gave it the name one pound. Some of the earliest known paper money dates to China's Tang Dynasty (618-907 C.E.). During the Ming Dynasty in 1300 C.E., the Chinese placed the emperor's seal and signatures of the treasury on a crude paper made from mulberry bark.

From the time of America's discovery in 1492 until the California gold rush in 1848, silver dominated in common circulation in America and Europe, while gold came into dominance after the discovery of gold in California and Australia. Under the rule of the British Empire, the British pound sterling and the gold standard were adopted around the world. In 1913, the gold cover for Federal Reserve notes was set by 1913 law to be 40 percent. In 1945, the gold reserves against Federal Reserve notes were reduced to 25 percent, and to continue the inflation spiral, this figure (the 25 percent) had to be reduced to zero. Toward the end of World War II, the U.S. dollar and gold became the principal international reserve assets under the Bretton Woods Agreement. The U.S. dollar became the world reserve currency, and it was treated as if it were gold because the agreement defined its value to be $35 per ounce of gold.

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