Early French paper currency part of an issue known as Promesses de Mandats Territoriaux
Fiat Money vs Commodity Money
The monetary system has always been central to the economy of any country. It consists of a set of mechanisms used by governments to provide money to the consumers and to control the exchange of money and its supply, especially by adjusting the rates of interest in the market.
The monetary system kept evolving over the years and new forms of money were introduced from time to time, but in a broader perspective, this system can be divided into two major categories. One is fiat money, which is also known as forced paper money, debt money, irredeemable paper money or managed money. The other category is commodity money, which is also known as metallic money, full-bodied money, precious metal money or hard money.
DIFFERENCE BETWEEN FIAT MONEY AND COMMODITY MONEY
1) Definition
So what are Fiat Money and Commodity Money? A fiat money is a legal claim as it attains all its properties from the law. It is just like a purchase voucher that can be used as an exchange for goods and services and its purchasing power varies. The only fixed right associated with the fiat money is the settlement of debts. It was first introduced as a convenient form of money so that people could carry paper backed by the government instead of carrying around gold or silver. However, with the passage of time, governments are less willing to back up their fiat money with gold or other forms of commodities, and it has lost its original value. Fiat money is intrinsically useless and so it cannot be redeemed for any other commodity. It is only valued as money because governments decreed that it has value for that purpose.
Commodity money, on the other hand, is money that derives its value from a commodity of which it is made. It can be exchanged on demand for a specific commodity. For example, commodities that are used as a medium of exchange include, copper, gold, silver, large stones, alcohol, tobacco, cigarettes, cocoa beans and barley. The gold standard is a good example of commodity money where people do not have to carry gold for trading goods. If a gold coin is made, the value of that coin would be measured in terms of the value of gold rather than its face value. The purpose of commodity money was to introduce a convenient form of trade because it’s superior to the barter trade system. However, one cannot ignore the fact that commodity money is subject to huge price fluctuation.
2) Payment Implications
Commodity money is a sort of money that is considered as a present good. Whereas, fiat money is a future obligation as it is simply a promise to pay in the future. Payment is never made when it comes to fiat money, instead it is only discharged. But commodity money, on the other hand, completes the transaction. Under a commodity monetary system, final payment is always made in the form of commodity that is being used as money in the transaction. The commodity is used as a final payment because there is no obligation and receiving the commodity in payment ends all further obligations.
Fiat money is a paper money and it represents nothing but a promise or an obligation. Under a fiat monetary system, final payment never occurs because a transaction is executed with a promise, a representation, or an obligation that something else is owed. Here, monetary unit is a legal fiction. It is not tangible and does not have any defined unit of measure.
3) Government Intervention
The quantity of money is not subject to governmental manipulation under commodity monetary systems like the silver or gold standard because it has a value of itself which is independent of its monetary use. On the other hand, the governments maintain control of the money under a fiat monetary system and can change the supply of money whenever they want to suit political considerations.
4) Determining the Quantity
Under a commodity monetary system, such as the gold standard, market forces determine the quantity of gold coined. The public at large decides the number of gold coins they need by the quantity of gold that was brought to the mint for coinage and by the number of gold coins that were melted for other usages. Therefore, it can be said that the value of commodity money is determined by the wisdom and knowledge of all the people who are regulating the supply of money.
In case of the fiat monetary system, governmental monetary policy is required to regulate the quantity of fiat money. Expert opinion is required for the development of this policy in order to achieve the desirable goals. However, the policy is entirely based on the personal value judgment of these experts and once the policy is finalized, government forces are required to implement this policy.
5) Nature of Currency
Fiat money is a political currency because political needs determine its quantity. It is directly associated with the government debt even if it is directly issued by the government and is interest free. Whereas, commodity money is an economic currency and its quantity is determined by the needs of the economy as it is associated with the production of real goods and services.
6) Determining the Value
Under a fiat monetary system, the governments are in a position to attain monopoly over money and by using their monopolistic control over money; they can inflate until the money is completely worthless. With commodity money, the value of commodity money is determined by the production of commodities.
However, it can be said that fiat money is initially dependent on commodity money for its value because something is demanded as a medium of exchange only if it has a pre-existing barter demand. Therefore, fiat money grows out of the commodity monetary system and is based on the phenomenon that the power of government provides value to a piece of paper that does not have its own intrinsic value.