What might cause a change in the value of fiat money? This is not monopoly money we are talking about here people, we are talking about the real thing. Cash, baby.
This is a legitimate question now more than ever, and there are many different reasons why this is a question that is getting more and more play. The reality is, fiat currency is a very loosely used term nowadays with the majority of monetary transactions happening paperless. As a society, for good or for bad, we have comes very far from dealing in gold and spices to being able to make a transaction by adding a few zero’s to the end of an Excel spreadsheet.
For better or worse, fiat currency has a different place in such a regulated economic environment. Not only are we going to spend the rest of this article answering the question “What might cause a change in the value of fiat money?”, but we are also going to speak about what can really impact fiat currency over the next 25 years or so. Strap in, this one is going to be a LOT more interesting than you originally thought.
For starters, what is fiat money? There are a lot of things in this world that are worth money and can be exchanged for goods and services like fine wines, or art, or a piece of paper with a former president.
When we speak about fiat money, are speaking about the actual Federal Reserve Note of physical cash.
These suckers are printed and created by one entity that is not part of the US Government, the Federal Reserve. This group is able to add a few zeros to an Excel spreadsheet, walk down the hall, and print as many of these suckers as they like.
And again, the act of doing so is 100% completely up to the Fed to do as they please. Besides the fact that the Fed, not being regulated or maintained by the US Government, can create money out of thin air (which should be scary), that creation of money has a profound impact on the value of the piece of paper they are printing.
How Creating Fiat Money Impacts the Money Supply of the Nation
It looks like those who work at the Fed are pretty trigger happy when it comes to walking over to the printing press and pressing the “start” button.
But what exactly happens when fiat currency is created? Remember, we are looking to find the answer to the question “what might cause a change in the value of fiat money?”
Think about this logically for a second. Let’s use a rare watch for this example.
What if I told you Rolex was going to come out with only ten watches next year? You would likely say those are rare and the price would be valuable. For argument’s sake, we can say that each of those ten Rolex watches is worth one million dollars. Seem fair?
But then what if I told you that rather than only making ten watches, Rolex decided they are going to make one hundred. What happens now?
The value of those watches goes down because there is more supply of watches. Where there was much less supply with only ten watches, there is clearly much more supply when there are one hundred in play.
If we backtrack to the Fed official walking down the hall to press the “start” button on the printing press for a second. In actuality, we are not talking about two completely different things here.
On one hand, we have more supply because there are more watches available. On the other hand, we have more supply because more money has been created. But what is the similarity between the two?
In both cases, the value of those products (Rolex and the currency) decrease. There is not a reason for the decrease in value except for simple economics of supply and demand. The more supply, the less demand, and thus, the lower value.
Don’t believe me, take a look at the purchasing power of the US Dollar over the last century. Looks like it is going in the complete opposite direction of the charge above which shows exponential growth in the money supply.
In 1913, when the Fed was created, the purchasing power of one US Dollar was…one US Dollar. In 2013, the purchasing power of one US Dollar was five cents. This is what happens when we continuously print money like it is going out of style. More and more supply gets created and the lower the value becomes.
What Else Can Decrease The Value of Fiat Currency?
There are a few other things that can decrease the value of fiat currency other than over-supplying the market.
Governments can absolutely impact the value of fiat currency and unfortunately, they seem to do so only negatively. For example, on May 4, 2016, Europe decided to phase out the 500 Euro Note. Officials claimed it was to stop transactions of narcotics, however, the damage was done. When a government stops the circulation of a certain type of fiat currency, they are pretty much telling you that they want to wind it down.
While this, for the most part, would be a sign of an increase in the value of the fiat currency (less supply), it does hurt the value of the currency as governments have the ability to completely phase out fiat money if they choose to.
Governments have the potential to disrupt the concept of supply and demand by regulation. By removing large valued fiat currencies, the government is able to decrease the value because they are showing they have the potential to end fiat currency in general.
Inflation also has the ability to not only decrease the value of fiat currency but also to reduce the value of currency in general.
Inflation according to Investopedia, is a general increase in prices and fall in the purchasing value of money. Let’s look at an example of this.
Let’s say three years ago, this box of Twinkies was selling for $1. Fast forward to today, the price of this box has double in that three years time to $2. The price has inflated by $1.
But what now? Because prices have increased, the purchasing power of that $1 goes down. Now we can only purchase half a box of these delicious Twinkies with that original $1.
This means that inflated prices are able to decrease the value of the currency as it reduces its purchasing power.
What Might Cause a Change in the Value of Fiat Money?
There you have it, folks. Just some of the reasons why we might see a drop in the value of fiat money. To recap, here are the three ways we spoke about:
- An increase in the money supply. The more dollars that are printed, the more supply there becomes. This means that the value of the fiat dollar goes down.
- Government. If the government is moving towards getting rid of fiat money, people will perceive fiat as having less value because it may be worthless (banned) one day.
- Inflation. Prices increasing without the value of the currency increasing at the same rate reduce the purchasing power of that currency and fiat money.