Pros and cons of a fiat currency
Pros of a fiat currency
Since fiat money is not a scarce or fixed resource – like gold – a country’s central bank has greater control over its supply and value. This means that governments can manage the credit supply, liquidity and interest rates more reliably.
Unlike commodity currencies, which could be affected by the discovery of a new gold mine, the supply of fiat currencies is regulated and controlled by the respective currency’s government. There is less risk of an unexpected devaluation caused by the supply of fiat currencies, as any increase in supply is a pre-empted decision made by a fiat currency’s government.
Cons of a fiat currency
Since it is not tied to a tangible asset, the value of fiat money is dependent on responsible fiscal policy and regulation by the government. Irresponsible monetary policy can lead to inflation and even hyperinflation of a fiat currency.
Adding to this, there is greater opportunity for bubbles with fiat currency – an economic cycle in which there is a rapid increase in price before an equally rapid decline in price.
The increased prevalence of bubbles is because fiat currencies have a virtually unlimited supply, which means that quantitative easing is an option for governments. While possibly providing stimulus to an economy, quantitative easing can also cause greater inflation rates. This could impact anything from housing prices to national debt levels, which in turn could impact the financial markets.