Fiat Money vs. Legal Tender: An Overview
Fiat money does not have any intrinsic value. What value it has depends on public confidence in the currency's issuer. Legal tender is any currency declared legal by a government. Many governments issue a fiat currency and then make it legal tender by setting it as the standard for repaying debt.
Key Takeaways
- Fiat money has no intrinsic value, while legal tender is any currency declared legal by a government.
- Governments can issue fiat currency and make it legal tender by setting it as the standard for debt repayment.
- The benefit of fiat money is that it gives central banks greater control over the economy, but governments can print too much money and create hyperinflation.
- The U.S. dollar is both fiat money and legal tender.
Fiat Money
Fiat money is not backed by physical commodities, such as gold. Instead, it is government-backed. Most paper currencies today are fiat currencies. Fiat money value is based on the relationship between supply and demand. Fiat holds value because of people’s faith in that nation’s currency.
In the past, governments minted coins or paper money tied to the value of a physical commodity, which could then be redeemed for a set amount of that commodity. Fiat money cannot be redeemed.
The benefit of fiat money is that it gives central banks greater control over the economy, as they can control how much money is printed. Inflation may occur when a government creates too much of a fiat currency, and the money supply increases too rapidly as a result. Governments printing too much money can create hyperinflation.
Legal Tender
Legal tender is any form of payment recognized by a government, used to pay debts or financial obligations, such as tax payments. National currencies, such as the U.S. dollar, are legal tender. In the U.S., the Treasury is authorized to create and issue dollars to the public. Federal Reserve notes and coins are recognized legal tender in the U.S.
Laws ensure nothing other than official legal tender gains enough traction to be used as money in the economy. Notably, checks and credit cards aren’t legal tender—rather, they are money substitutes.
The U.S. dollar is both fiat money and legal tender. In 1933, the U.S. federal government stopped allowing citizens to exchange currency for government gold. The gold standard, which backed U.S. currency with federal gold, ended completely in 1973 when the U.S. also stopped issuing gold to foreign governments in exchange for U.S. currency notes. Dollars are now backed by the U.S. government itself. As legal tender, the dollar is accepted for both public and private debts.
The dollar's value fluctuates with economic conditions and the federal government's management of interest rates. Since the government controls the money supply, it may print more dollars and create higher inflation as needed to influence economic conditions. As changes in public confidence in the U.S. government occur frequently, the value of the dollar may change rapidly even without ongoing federal management.
Special Considerations
Cryptocurrencies are not considered money (i.e., accepted for use) in most parts of the world, as it does not have legal tender. However, El Salvador became the first country in the world to accept bitcoin as legal tender in June 2021.
Meanwhile, some currencies, notably the U.S. dollar, are considered legal tender in countries that issue no currencies of their own. Ecuador, which does not issue a legal currency, has used the U.S. dollar as its legal tender since 2000.This practice of using the U.S. dollar as a country’s primary currency is known as “dollarization.”
FAQs
Fiat money is a legal tender (a currency declared legal by the government), and its value is backed by the issuer (the government). On the other hand, cryptocurrency is a digital currency backed by decentralized blockchain technology, meaning it's not backed — or regulated — by a central authority like a government.
Is legal tender fiat money? ›
The U.S. dollar is considered to be both fiat money and legal tender, accepted for private and public debts. Legal tender is basically any currency that a government declares to be legal. Many governments issue a fiat currency, then make it legal tender by setting it as the standard for debt repayment.
What is a fiat money in simple terms? ›
A fiat money is a type of currency that is declared legal tender by a government but has no intrinsic or fixed value and is not backed by any tangible asset, such as gold or silver.
What is the difference between legal tender and money? ›
Legal Tender refers to all U.S. coins and currency that issued by the government. U.S. Cash dollars are also a valid form of legal tender. Nonetheless, federal statutes do not require a seller to accept cash as a form of legal tender for payment of goods or services that were rendered.
What are the disadvantages of fiat money? ›
Disadvantages of fiat money
This can lead to a vicious cycle of debt and inflation, potentially leading to economic bubbles. Dependence on government values: Fiat money gets its value from the trust and confidence placed in the issuing government.
What is an example of a fiat money? ›
In the U.S., a single dollar was redeemable for gold until 1933. Over the past century, governments have moved away from the gold standard. Currencies now are almost universally backed by the governments that issue them. An example of a fiat currency is the dollar.
What is the U.S. dollar backed by? ›
Prior to 1971, the US dollar was backed by gold. Today, the dollar is backed by 2 things: the government's ability to generate revenues (via debt or taxes), and its authority to compel economic participants to transact in dollars.
Is the U.S. dollar fiat money? ›
The U.S. dollar is both fiat money and legal tender. In 1933, the U.S. federal government stopped allowing citizens to exchange currency for government gold.
Is bitcoin fiat money? ›
Bitcoin distinguishes itself from fiat currencies through mechanisms like the Bitcoin halving that controls its inflation.
Are pennies considered legal tender? ›
While federal law states that coins are legal tender, it does not compel anyone to accept them. If a business doesn't want to take pennies — or a $100 bill, for that matter — it has a legal right to refuse them. So why does the government keep the penny around? The answer is simple: sales tax.
What is the safest currency in the world? The Swiss franc (CHF) is generally considered to be the safest currency in the world and many investors consider it to be a safe-haven asset. This is due to the neutrality of the Swiss nation, along with its strong monetary policies and low debt levels.
What is a major danger of fiat money? ›
Fiat money is at risk from inflation. As prices increase, a unit of currency buys less. If the government tries to compensate by printing too much money, the value of its currency drops further.
Are credit cards fiat money? ›
Checks and credit cards are modern examples of representative money. While a government backs fiat money, representative money can have backing from many potential assets. In the case of checks and credit cards, they're backed by the money in a bank account.
What type of money is declared legal tender? ›
Fiat money is declared legal tender by the government that issues it. This includes money in circulation such as paper money or coins.
What are not considered as fiat money? ›
Gold is not considered fiat money. Fiat money is the currency issued by the government which is not backed by any physical commodity such as silver or gold. Paper currency, coins, and demand drafts are fiat money.
What money is not legal tender? ›
Coins and banknotes are usually defined as legal tender in many countries, but personal cheques, credit cards, and similar non-cash methods of payment are usually not.
Are both fiat money and cryptocurrency legal tender? ›
Fiat currencies are legal tender controlled by governments. Cryptocurrencies are digital assets that use blockchain technology.
