Fiat vs. Commodity Backed Currency

[amadeus]

As much as I understand about both of the concepts, I still don't know much of the pros and cons of having either one of those systems. For those of you unfamiliar, fiat money is backed by the full faith and confidence of the issuer, whereas commodity-backed money is of course backed by some commodity (gold, silver, frozen concentrated orange juice, whatever.)

So can the economics geeks kind of condense the arguments into a "Dummies" version as to why one system or another might be superior? I've heard the arguments for both and it sounds like to me on the surface that either system has validity.

However, I know the truth is that how our currency is supplied to us is a major component of our economic structure. So, economists, throw me a frickin' bone here!

 

[general_kill]

As much as I understand about both of the concepts, I still don't know much of the pros and cons of having either one of those systems. For those of you unfamiliar, fiat money is backed by the full faith and confidence of the issuer, whereas commodity-backed money is of course backed by some commodity (gold, silver, frozen concentrated orange juice, whatever.)

So can the economics geeks kind of condense the arguments into a "Dummies" version as to why one system or another might be superior? I've heard the arguments for both and it sounds like to me on the surface that either system has validity.

However, I know the truth is that how our currency is supplied to us is a major component of our economic structure. So, economists, throw me a frickin' bone here!

Fiat encourages economic growth and is probably more stable than commodity backed currency if the government backing the currency is strong enough.

Commodity backed currency is better at protecting a currency from inflation/deflation or exchange rate changes.

 

[JerichoHill]

Congrats general_kill, you have correctly identified the strengths of fiat and commodity based currencies.

 

[amadeus]

And a rather unceremonious entrance by Jericho spoils the thread.

 

[Mise]

Commodity-backed currency is basically fiat currency based on the perceived, subjective value of some commodity. Gold is practically almost useless*. It has value because other people think it has value, and have faith in its future value. Now, there's nothing wrong with that, but it's no difference than saying that this bit of paper with Andrew Jackson's face on it has value because other people think it has value, and have faith in that continuing in the future.

In other words, it's all the same. Except with fiat currency you get more flexibility (the Gold Standard only "protects" against inflation/FX because there's less flexibility!).

EDIT: *-I should point out that we'd find more uses if it was cheaper...

 

[general_kill]

Commodity-backed currency is basically fiat currency based on the perceived, subjective value of some commodity. Gold is practically almost useless*. It has value because other people think it has value, and have faith in its future value. Now, there's nothing wrong with that, but it's no difference than saying that this bit of paper with Andrew Jackson's face on it has value because other people think it has value, and have faith in that continuing in the future.

In other words, it's all the same. Except with fiat currency you get more flexibility (the Gold Standard only "protects" against inflation/FX because there's less flexibility!).

EDIT: *-I should point out that we'd find more uses if it was cheaper...

I think there is a little confusion here because the definition of fiat money is something decreed by the government as legal tender. I do not think the government legally require anyone to accept gold or other commodities as legal tender.

Your views on the arbitrary value of gold also applies to everything else in life. These values are are easily determined due to our use of currency. Currency serves 3 roles:
- medium of exchange
- store of value
- unit of account

Many commodities have been used as currency in history and they all share some common traits. These traits include but are not limited to:
- Rarity
- Difficult to forge/counterfeit
- Measurable
- Convenient
- Probably more traits I'd have to dig through my notes from last year to find.

What is unique about gold that separates it from paper money is its rarity. The supply is controlled therefore the equilibrium value of it will not change because a government is in debt and decides to make more gold. Paper money--on the other hand--does not have such a limitation. A government can completely devalue it currency by printing out a lot of money.

 

[Mise]

I think there is a little confusion here because the definition of fiat money is something decreed by the government as legal tender. I do not think the government legally require anyone to accept gold or other commodities as legal tender.

What I meant was, what supports the value of paper money is the same thing that supports the value of commodity-backed currency.

What is unique about gold that separates it from paper money is its rarity. The supply is controlled therefore the equilibrium value of it will not change because a government is in debt and decides to make more gold. Paper money--on the other hand--does not have such a limitation. A government can completely devalue it currency by printing out a lot of money.

Which is what I meant by flexibility. Gold only "safeguards" against inflation/FX because it is inflexible.

 

[admiral-bell]

Commodity-backed currency is basically fiat currency based on the perceived, subjective value of some commodity. Gold is practically almost useless*. It has value because other people think it has value, and have faith in its future value. Now, there's nothing wrong with that, but it's no difference than saying that this bit of paper with Andrew Jackson's face on it has value because other people think it has value, and have faith in that continuing in the future.

In other words, it's all the same. Except with fiat currency you get more flexibility (the Gold Standard only "protects" against inflation/FX because there's less flexibility!).

EDIT: *-I should point out that we'd find more uses if it was cheaper...

silly question: What if we based a currency on something with a definite value, like energy or water?

 

[Narz]

Commodity backed currency is better at protecting a currency from inflation/deflation or exchange rate changes.

Why is that so? You'd think it would be the opposite.

 

[Irish Caesar]

silly question: What if we based a currency on something with a definite value, like energy or water?

Because nothing really has a "definite value," certainly not those things.

Tap water and bottled water sell at remarkably different amounts.

The price per unit of energy from different sources is probably an even wider range...

Value is only what people think it is.

 

[Princeps]

Gold Standard is actually inferior in almost every way, at least if we look at history.

 

[Rossiya]

By the way, do you get Fiat cars in America?

 

[Cutlass]

silly question: What if we based a currency on something with a definite value, like energy or water?

There is no such thing as a commodity that is not variable is value depending on the circumstances. Nor is there one that is fixed in quantity. Gold was used because people perceived it to be of value, and in gold's favor was that the physical supply of it typically only changes by a small percentage year to year. Making it's quantity more or less predictable. There have been situations where silver quantities increased rapidly enough to cause general inflation. But that's not really common either.

For any commodity, if it is valuable enough, people will put more effort and investment into finding more of it. So there is no actual "fixed value".

And there's the further problem that any commodity is unlikely to expand (or contract) at the same rate that the economy wants to expand. And in those cases the money supply can strangle the economy.

 

[Princeps]

Gold was used because people perceived it to be of value

Gold was originally used as medium of exchange because it was rather rare but not too rare and easily molded into convenient shapes and sizes, like coins. Also, kings and authorities could easily put their face on it, again because it was soft and easily shaped.

But gold wasn't expensive merely because of perceived value or because it could be used jewelry or something. The metal had no inherent value, instead gold was backed with some animal or commodity. So you could say that gold was used as a Cow Standard in ancient societies.

 

[Godwynn]

By the way, do you get Fiat cars in America?

They have to be better than GM.

 

[Irish Caesar]

Fix it again, Tony!

 

[Mise]

You can't fit the average American inside a fiat. Not even one with 4 doors.