“No doubt all commodities have politics. But money and credit and the structure of finance piled on them are constituted by political power, social convention and law in a way that sneakers, smartphones and barrels of oil are not. At the apex of the modern monetary pyramid is fiat money. Called into existence and sanctioned by states, it has no “backing” other than its status as legal tender.”

CRASHED: HOW A DECADE OF FINANCIAL CRISES CHANGED THE WORLD, ADAM TOOZE (2018)

What is fiat money? Do we not live in a world of fiat money? Is it correct to say that money “has no “backing” other than its status as legal tender.”?

Fiat Money is token whose value is bestowed by virtue of state decree. It is mere pieces of paper, intrinsically worthless, that were treated a money only because a government insisted that they should be.¹ It perpetuates a belief that money can just be printed by the state through the aegis of the Central Bank – in a sense creating money out of thin air. But fiat money, historically, has been a replacement of already existing commodity-based credit systems – what made a particular commodity ‘money’ was not that it functioned as currency, but that it functioned as the material in which the value of other commodities were denominated. So, states/empires, in effect, appropriated these systems by issuing standardized currencies based on some conversion rate.

To say that we live in a world of fiat money would be misleading. The modern money that we use for transactions is a state IOU, driven by a socio-political contract of the state with its citizens. It is essentially based on debt the state owes to entities that finance its borrowing. Since the state is vast payment community due to its powers of taxation and political contract, its IOUs serve as currency for domestic transactions. At the same time, state has the best IOUs because it has the best assets – the people, who produce goods and services and who pay taxes.

So, money is not fiat money but state credit money. The state being an economic beast precisely because it is a political leviathan. Hence, it is wrong to say that money has no backing other than its standing as legal tender. It looks and feels like fiat because it allows for seamless transactions, as if it is a thing. In fact, it is backed by the political legitimacy of democracy (e.g. India) or of outcomes (e.g. China).

When central banks print money (liability), they buy treasury bonds (asset) which monetizes the debt owed by the government to other banks. These banks cannot print money themselves, but they are allowed to create virtual money by making loans at fractional reserve rate established by the Fed. These are private IOUs which also can be used for transactions and whose “value solely rests on the assumption the IOU itself can serve as a socially valid means of exchange”². This is determined by the creditworthiness of the originator of these IOUs. However, these private IOUs also get transacted in the real economy through the state credit money. This backing of the state makes it seem as if these IOUs i.e. promises to pay are, for all legal purposes, identical to payment in commodity money or in kind. This is not actually the case in the present system of state credit money.

References:

1. Graeber, D. (2011). Debt: The First 5000 Years. Penguin
2. “A vast machine for the provisioning of soldiers” (2016) The Real Movement. Retrieved from https://therealmovement.wordpress.com/2016/11/17/a-critical-review-of-david-graebers-debt-3/