Fiat money is not guaranteed and limited by any other value, such as gold or silver. Since it is not tied to a scarce other material, it can theoretically be produced indefinitely. We have had pure official fiat money since 1971, when the US abolished the last indirect remnant of the gold standard. Up to that point, the US central bank, the Federal Reserve or ‘Fed’, still promised one ounce of gold for every 35 dollars. But the guarantee only applied to foreign central banks that belonged to the Bretton Woods monetary system – and only until European central banks threatened to exchange all their dollars for gold. When that happened, the USA simply withdrew the gold cover for foreign dollars, instead of risking to lose their gold reserves. Even without the gold, the currencies retained their value. At that point it became obvious that it was not the gold standard that made the monetary system work.
According to the MMT-analysis, the worth of the currency is established and maintained by taxation. The state taxes its population and will only accept its own currency for payment. Thus, people will accept the currency also from each other, knowing that they themselves will find others who will accept the money for payment as everybody needs it to pay taxes. Furthermore, taxation makes sure that enough money returns to the state so that the state can spend new money every year without creating inflation over the time. If the risk of inflation were to emerge however, the state could simply raise taxes to take away money and therefore reduce demand from households and companies.
The big advantage of fiat money is that the state always has the money to fulfil its tasks. It can always pay people to work as teachers or judges and buy the necessary materials to construct schools and courts. The state can use its own currency to pay for all available goods and labour in its own jurisdiction – at best for the benefit of the general public. In a democracy, fiat money is created in the course of the democratic processes, when government and parliament decide on a Budget Act in order to implement political and social goals. The thereby enabled expenditures end up in the accounts of the beneficiary households and enterprises.
The term fiat money has its origins in the Latin word “fiat”, which means “let it be done”. Just as God says: “Let there be light” at the beginning of the Bible, the state says, “Let there be money”. And there it will be. Even though unlimited fiat money may seem crazy and unsound at first glance, it effectively increases the state´s stability and independence. Not only does the state always have the money required to fulfil its tasks. Furthermore, it does not make promises it cannot or does not want to keep in case of emergency, as was often the case in the times of the gold standard. The state guarantees nothing else than that it will always accept its currency for tax payments. And so it does. What’s more, if the state issues government bonds, then it commits to returning them in its own currency when they mature. Since it can produce the currency limitlessly via its central bank, the refund is always possible. Thanks to fiat money, the state central bank can also provide unlimited guarantees for the banks. During a bank crisis, it is sufficient most of the time to lend the banks large amounts of non-cash central bank money. In a worst-case scenario, facing a large bank run, the state would simply have to keep printing bank notes until everybody calms down again.
According to our accounting system all money is always registered with an equal high debt, and this applies also to the state money creation. But this must not mislead us. Debt in a country’s own currency is not like normal debt. It is the debt of the money monopolist, and it can always be repaid. It is the registration of the state money production, as in our accounting system all money is always registered with an equally high debt. And there is a counterpart to the debt of the government in the form of assets: thanks to government debt, other (sub)sectors such as households can have net savings.
