Fiat Money
Fiat is Latin for ‘let it be done’. A fiat currency has no intrinsic value and is created into existence by law. The government commands it to be currency and so it becomes currency.
Prior to 1971 government spending was constrained by a gold standard system of monetary management which established the rules for international commercial and financial dealings. It was agreed at Bretton Woods and was set up in 1944. Sterling wasn’t directly convertible into gold, but the value of the pound was fixed against the US dollar and that was convertible. This meant that the government had to defend the pound in a fixed exchange rate system forcing it to adopt policies that were not in the best interests of citizens.
The number of pounds in circulation was restricted by the amount of gold and dollar stocks held by the government. In this way the government appeared to be revenue constrained and an illusion was created that it could only ever get its money from taxes with any shortfall made up by borrowing.
As a result of the first oil crisis, in 1971 Bretton Woods was abandoned and the pound was no longer pegged to the dollar. We entered the era of free-floating currencies. From then on, the value of the pound was decided on the international markets and this remains the case today. But the household budget narrative of taxing and borrowing to spend persists.
What gives fiat money its value? Professor L. Randall Wray explains the Modern Money Theory view that “taxes drive money.”