Fiat Money v/s Commodity Money | What's the difference?

At present, money has become the bedrock for trading practices between persons or business entities. In earlier times, when the concept of money had not yet been introduced, barter systems enabled these transactions. A barter system is the exchange of goods and services for goods and services without the involvement of money. With evolution came an evolution in the concept of money. In earlier times, gold, silver, or other metallic coins sought weight to transact. 

Today, we use different forms of money, including cash, NEFT, cheques, UPI, etc., in our daily lives. However, if we zoom out and see the broader picture, these forms of money can be classified into two major categories: Fiat Money and Commodity Money. Discover why understanding Fiat and Commodity money is crucial for your financial future.

What is Fiat Money

Fiat money does not have any value of its own and is not backed by any tangible or physical asset. The notes we circulate in our daily transactions are significant examples of fiat money. The intrinsic value of fiat currency resides in the authority or power defined by law which is recognised by its citizens and is thus supported by their government. All countries have their paper currency in the form of fiat money. The US dollar, Euro, and Indian rupee are examples in which such currencies are given wide recognition as legal tender for payment of all forms of debts in trade or transactions. 

What is Commodity Money 

Commodity money is that which has value built from its nature and properties. In earlier times, some of the commodities used as money included gold, silver, copper, rice, and even shells. Such commodities had intrinsic value on their own and could be accepted for trading goods. Take for example the ancient coins of gold and silver.  

People didn't just use them for buying and selling; they also prized them for their usefulness and good looks.

Differences between commodity and fiat money shall include:

Intrinsic vs Extrinsic Value:

Commodity Money: Must have real value; the material itself is worth something.

Fiat Money: Doesn't have any real value; the government declares it worthy.

Supply Control:

Commodity Money: Supply is fixed at obtaining the maximum of the currency in use.

Fiat Money: Both the monetary policy and the government's mode in issuing the piece of currency provide more control to the people.

Stability and Inflation:

Commodity Money: Its value holds better because it is linked to something physical.

Fiat Money: Can devalue much easier due to unwise manoeuvrings as it is reliant on people's trust and what the government does.

Examples of Commodity and Fiat Money

Commodity Money:

Gold and silver coins that were used in economies of the medieval ages and antiquities.

Shells like cowries, common to many cultures employed these as media of exchange.

Some commodities, such as salt, became so valuable in certain regions that people employed them as money.

Fiat Money:

Paper currency in use today: i.e., the dollar, the euro, or the Indian rupee.

Inexpensive common metals used for most daily commerce would not, of themselves, be seen as having inherent worth.

Some Advantages of Fiat Money

Fiat currency has more advantages over commodity money, thus includes:

Monetary Control: Since governments and central banks have the power over money supply, they can address other economic matters, such as inflation, economic depression, and unemployment.

Cheaper Production: The cost of producing fiat money is significantly lower than what it would take to mine and mint commodity money.

The Specific Use: Such small coins are large in number and hence they are to be included in commoditized money. 

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The Transitioning from Commodity to Fiat Money

The transition from commodity money to fiat money dates back as far as various developments below:

Economic Climates: National economies became huge, requiring a much more supple and abundant money supply.

Securing Money: It became very hard to store and move larger amounts of gold and silver, so people started using paper money.

Government Puppetry: With fiat currency, they could easily control the economy. It has become easier for the government to manipulate the amount of money in circulation and apply other monetary policies.

Conclusion

When we look into the vanishing distinctions that set commodity money apart from fiat money, we see that the two systems have changed sufficiently to understand how tricky monetary policy becomes. Commodity money has an intrinsic value; fiat money only has value because trust in it exists and governmental support is behind it. 

Cheaper Production: It costs much less to produce fiat money than to mine and mint commodity-based money.

Easy Usage: Its lightness and reduced economic congestion allow fiat currency to compete against commodity money.

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FAQs (Frequently Asked Questions)

1. What is the difference between fiat money and commodity money?

Fiat money includes paper notes and coins, while commodity money includes gold, silver, and other metal coins. 

2. What is the difference between the value of money and the commodity value of money?

The commodity value of money refers to the value of the commodity (such as metal) from which money is made. Thus, in the olden days when coins were made of gold or silver, the commodity value of money was the market value of the gold or silver contained in the coin. 

3. What do you mean by money value?

Monetary value is the worth of something measured in currency. In a contemporary economy, nearly everything of value can be measured by its monetary value. The price, or monetary value, of anything, is determined within the marketplace and is based on the law of supply and demand.

4. Which relation is between the value of money and the price level of a commodity?

Value of money is what one unit of money can buy and price level is the average of prices of all the goods and services within an economy. So when the price level increases the value of money goes down and vice versa. Hence the relationship between price level in an economy and value of money is inverse.