Are Fiat Currencies Considered Sound Money?

Fiat currencies refer to a government-issued currency that is not backed by a physical commodity like gold or silver. Instead, it gets its value from public trust. Consumers continue to trust the money and participate in the economy in proportion to their trust in the government and economy.

In contrast, sound money refers to currency that gets its value from supply and demand. Its scarcity keeps it from appreciating or depreciating in value. Based on these factors, fiat currencies are not sound money. 

Over time, the United States transitioned from a sound money-based economy to a fiat currency. This transition raises some questions about the nature of American money. We'll explore these questions in this guide.

What is Sound Money?

As we've already mentioned, sound money refers to a currency that is stable and unlikely to appreciate or depreciate in value over time. This stability comes from several factors, including:

• scarcity
• durability
• divisibility
• portability

Scarcity refers to a limited supply that cannot easily increase. This is why, traditionally, sound money has taken the form of precious metals. Gold and silver exist in limited quantities, so they cannot be minted in vast quantities. 

The other factors similarly apply to precious metals. Metal is durable, unlike paper currencies. 

It is also divisible, meaning that it can be broken into smaller quantities. For example, American coins used to have large percentages of silver in their composition, but the coins were of differing values. Those coins are also very portable. 

Precious metals are not the only iteration of sound money. Prior to the 1970s, American money was backed by precious metals. 

During that time, American currency likewise qualified as sound money. Since even paper money was tied to precious metals, its value had the same advantages as those metals. 

As an addendum, experts have also debated whether cryptocurrency is sound money. It does meet many of the qualifications we've discussed, though it also has unique disadvantages that traditional sound currencies avoid. You can learn more about this argument here. 

How Do Fiat Currencies Compare to Sound Money?

Fiat currencies differ from sound money in several ways. The key differences relate to the following features:

• Lack of intrinsic value
• Supply control 
• Centralization
• Trust & stability 

Lack of Intrinsic Value

Fiat money (such as the US dollar or the Euro) has no intrinsic value. Instead of deriving its value from its own composition, its value comes from government decree and government trust. 

Why does this matter? The answer lies in sound money's limited supply. It's very difficult to continue striking precious metal currency. 

The advantage of sound money like gold is its stability. However, stability can be a disadvantage in times of crisis. If the currency can't adjust to the crisis, it may prolong the crisis. 

In contrast, fiat currencies can adjust their value. This ability comes from another core feature of fiat currencies that we'll discuss next.

Centralization and Supply Control

Fiat money is controlled by either a central government or bank. In the U.S., that central bank is the Federal Reserve. 

As a result, the centralizing entity can respond to changes in monetary policy. Similarly, it can respond to changes in the economy. 

The reason for this control is that the centralizing entity can print money at will, allowing its value to fluctuate. It can inflate currency by printing a surplus, or it can halt lower inflation by printing less money. It may also adjust the national interest rates to accommodate for changes.

However, there is a downside to this approach as well. Inflation can often be a contributor to economic decline. It also runs the risk of different government administrations having vastly different economic policies, which can cause fluctuation in the monetary supply. 

Trust & Supply

Fiat currencies gain their stability from government trust. National populations tend to trust their governments to print money in ways that meet the economy's needs. 

In the United States, there is another reason why fiat currency enjoys more trust than traditional sound money. The only legal tender recognized in the U.S. is the dollar. 

Legal tender is a form of currency that all entities must accept as payment. Cryptocurrency is increasingly accepted as payment by many companies, but no company is legally required to accept it.

In contrast, precious metals are rarely ever considered as currency. Usually, they are treated as a commodity for purchase. Although some states have passed legislation to treat precious metals as a form of legal tender, they rarely use precious metals as currency. 

Instead, the laws primarily exist to eliminate taxes pertaining to precious metals sales. This policy does cut back regulation that can harm sound money transactions, but the chief transactional currency is still the U.S. dollar.

What Advantages Do Precious Metals Have?

The modern American economy is designed with some prejudice against precious metals, but that doesn't make them useless. Precious metals remain a valuable investment due to its best quality: stability.

Precious metals are excellent at retaining their value over time. They are highly resistant to inflation; because of this, many investors invest in precious metals to hedge against inflation. 

The values of metals can also increase over time. Silver has had steady increase in value over the last year. 

Cryptocurrencies are also resistant to inflation, and crypto enthusiasts will recommend investments in cryptocurrency for this reason. However, cryptocurrencies often have severe fluctuations in value. 

Sometimes that's positive, such as in the 2017 Bitcoin bubble. Other times, however, the value of digital assets can plummet. For these reasons, many investors remain unconvinced that cryptocurrencies are good long-term investments.

Precious metals do not have that stigma. Moreover, they have the advantage of a longstanding history. 

Until the 1970s, the U.S. backed its currency with gold. That system was known as the Bretton Woods system. As such, gold has been a part of the American economy for centuries. 

Final Considerations of Fiat Currency

Fiat currencies are very different from sound money. U.S. fiscal policy currently says that fiat currency is the only form of money that the federal government recognizes as legal tender. 

In contrast, traditional sound money like gold and silver remains a worthwhile investment. While fiat currencies are prone to inflation, sound money can help investors hedge against inflation. 

We hope this guide was helpful! If so, check out our other articles on this site.