Money is just a piece of paper but this piece of paper holds so much value. Ever wondered why a piece of paper decides what worth of product you can buy?
Let’s understand the concept of fiat currency with a simple story.
In the old system people would trade by exchanging one thing from another. For example if you want a dress but only have apples to offer in return, you’d buy the dress in exchange for apples. Or service for service. You want the cobbler to mend your shoe but you only know how to cook so you will cook for him and in return he will mend your shoe. Product for service or service for product was also used! This system was known as barter system. But this system was really complex. One party could benefit and the other could be at loss. It was rare for the exchange to be truly equal!
So the rulers solved this problem by issuing gold coins. They took all gold from people and gave them coins fixing their value (this coin costs this amount of gold). This was the gold standard. Dealings became easier, everyone was happier. But then great wars like world war 1 & 2 happened. Every country participating in war lost its resources, money, gold, food, infrastructure. The gold started to decrease creating panic among people who started to complain to their governments about gold becoming less. Now the rulers became worried: what if everyone eventually asked for its gold back?
Here they introduced the concept of fiat currency. As USA was the land of factories before WW2, many countries of Europe would buy from USA sending them payment in gold. And in WW2, European countries lost almost everything, but America was different. Its land didn’t see great wars and hence its factories remained working and now after ww2, America was the only country which had larger gold reserves. In a meeting of rulers of 44 countries (Bretton Woods 1944) , it was decided to peg their county’s currency to dollar. Which means 1 currency note would be equal to X dollars and X dollars could buy Y amount of gold. This happened partly because America’s economy was already good and international dealings were being made in dollars by 1944. America had the gold and power so their currency started to lead the world.
But then in 1971, America decided not to back money with gold. Why? Because it had lost a large amount of gold in Vietnam war. Here the real switch occurred! The currency is now nothing more than a promise made by government. Only trust and rules! Now the government prints only the amount of notes that would keep the economy stable. Money is just a piece of paper today and it holds value only until:
People keep trusting the government.
Economy is stable.
Government does not print a large amount of currency notes.
This is true for every currency in the world today: dollar, euro, rupee, yen, all of them. Gold coins have been replaced by paper promises, and paper promises only work as long as people believe in them.
Your currency has value only because the government has a promise backing it. So next time you hand over a currency note, remember you're not really paying with paper. You're paying with trust