Money, in and of itself, has no value. It’s symbolic of the value that people place on it.
For example, when people in China grew tired of lugging around their gold coins to pay for things, they converted their currency into paper. The paper money was symbolic of the gold that was stored with a trusted agent and ultimately owed to them. Check out our last blog post for more on the history of paper money.
The U.S. adopted this idea of exchanging notes, or paper money, for gold in 1879. This system was called the Gold Standard. Paper money was fully convertible, and the American people were able to visit any financial institution to trade their paper money in for the appropriate weight in gold.
It wasn’t until the financial crisis in 1933 that President Franklin D. Roosevelt suspended
the Gold Standard in the United States. During this time, large quantities of gold were leaving the Federal Reserve at a higher rate than it was returning. This gold was primarily flowing both into foreign nations and into the American population. Both parties were “hoarding” gold for fear of the American dollar's devaluation.
F.D.R.’s push for a currency reform effectively weakened the paper dollar’s relationship with gold. The U.S. officially ditched the Gold Standard during the Nixon era, and this rejection of gold backing the value of the paper dollar is what transformed the States' currency into fiat money.
Fiat money is a government-issued currency that is not backed by a commodity, such
as gold or silver. The value of fiat money is derived from the relationship between supply and
demand, rather than the worth of a commodity backing it.
Fiat money allows for the United States' central banks to have greater control over appreciating and depreciating the value of the U.S. dollar. This control can be a useful tool for mitigating natural economic booms and busts. Fiat money, however, leaves an economic cycle susceptible to inflation, or even hyperinflation.
Inflation is when the general level of prices of goods will go up and more money will be
needed to pay for these goods. Prices and the amount of money circulating in the economy
have a very close relationship. If the government prints too much money, then prices will rise
and an individual will have to spend more money to pay for goods.
Hyperinflation is inflation that is, frankly, out of control. Germany is an excellent example of hyperinflation. In the 1920s, Germany's solution for having to pay for goods and services was simply to print more money. This didn’t actually solve their issues, and the German people had to carry way too many banknotes for basic commodities, such as bread. In fact, some families had so many banknotes that children would actually use them to make kites.
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