It is evident that most of us have heard a lot of controversial talks on wealth, created out of thin air by the Federal Reserve’s in the U.S.. Most of the population, especially the young age tends to think that the dollar in their wallets hold an intrinsic value, by that is it’s a dollar, but on contrast, most of the U.S currency is considered fiat, like any other currency accepted in the world. Fiat currency holds value mainly because the U.S government has accepted it as a legal tender to transact taxes and debts. The commodity hard money system e.g. precious metals like silver and gold are an alternative to fiat currency, although the barter system is inappropriate for large scale terms. In a system, of hard currency commodity notes are redeemable at any period of time.
The gold standard proponents argue that, since fiat currency does not hold any world real value, other than being declared by the state to hold value, that under what circumstance it should not be allowed as legal tender circulation. Carrying out trading transactions using fiat money is similar to trading a valued commodity with a worthless piece of paper.
The proponents of fiat currency argue that historical reasons validate precious metal to have real value, and thereby backing the state economic growth due to the limited highly valued metals. The government has the task of redeeming fiat money as the population grows, otherwise; the notes money suffer scarcity, and there will be no frequent commercial transactions. This would to the biggest monetary disorder, inflation.
A fiat system requires fraction reserves, a system that requires banks to hold a given percentage of the deposits at hand for withdrawal. This is a significant cause of inflation and negative business cycle, but on the contrary, the bank will always have a way to create money to maintain a certain percentage of the actual deposits at hand. Pros and cons of a fiat money system mainly occur as a result of a weakening U.S dollar.
Pros of a weakening U.S dollar:
>Fiat currency makes the U.S dollar competitive in the world markets relative to other currencies.
> The U.S industries get long term employment contracts. (Morrill, 1969).
>Faster growth of the U.S tourist industry as visiting the U.S is less expensive.
>Government revenues generated from taxes are substantially increased. Besides, trade deficit is as well reduced helping balance the budget and deficit of the current account.
>Pros boost the production of domestic industries and employment contracts thereby, replacing imported expensive items in countries whose exchange rates are extremely high.
>It generates foreign investments as U.S securities and assets become less expensive. Paradox to what is commonly known that a falling currency scares away investors.
The cons of having weak U.S dollar are:
>It makes travelling to foreign countries extremely expensive thereby discouraging the locals from travelling to other countries.
>Prices of essential imports like oil are significantly increased resulting to inflation because producers shoot up commodities prices to maintain a high profit margin. (Heffernan, 1996)
>Deterioration of political image as it implicates lack of proper monetary and fiscal policies and the consequence trading imbalance.
>Promotes high interest rates in an effort to attract foreign investments to finance the trading deficit, which may result to U.S recession.
>It could lead to the collapse of the U.S dollar and this may trigger market chaos, as most the world markets highly depend on the U.S markets.
In conclusion, therefore, to simplify transactions a fiat money system is necessary in vast marketing environment, to back up the commodity currency.