Why is Fiat Money Valuable?
1. Government Backing: Fiat money relies entirely on the trust and confidence placed in the government that issues it. This backing serves as the foundation for the currency’s value, instilling widespread acceptance among the public and ensuring its viability as a medium of exchange.
2. Legal Tender for Tax Payment: Governments mandate that taxes must be settled using the fiat money they issue, creating a perpetual demand for the currency. This requirement compels individuals and businesses to acquire and utilize fiat currency to fulfill their tax obligations, contributing to its continuous circulation and acceptance.
3. Chartalism: Chartalism posits that people willingly accept fiat money because of its necessity for tax payments. The compulsion to settle tax liabilities, backed by potential penalties or legal consequences, drives the universal acceptance of fiat money. This foundational concept of capitalism underscores the crucial role of tax obligations in shaping the circulation and acceptance of fiat currency.
4. Credit Theory: The credit theory challenges the notion that money must be backed by a tangible asset to maintain its value. According to this perspective, money’s essence lies in its function as a credit-debt relationship, rendering the backing of a physical commodity less critical in determining its value. This theory emphasizes the inherent credit-based nature of fiat money.
5. Government Control: Governments wield fiat money as a tool to foster economic stability, providing a mechanism to navigate economic cycles. The value of fiat money is intricately linked to a country’s economic performance, governance policies, and their impact on interest rates. This interconnection allows governments to exert control over economic fluctuations, contributing to overall stability.
6. Universal Acceptance: Fiat money’s universal acceptance, coupled with its relatively stable value, facilitates ease of control for banks and lending institutions. The determination of interest rates, supply, and liquidity becomes more manageable as the value of fiat money is predominantly influenced by broader economic factors. This universal acceptance streamlines financial operations and contributes to the currency’s role as a reliable medium of exchange.