Commodity Money vs Fiat Money
Both commodity money and fiat money can be used in the payment of goods and services, even though commodity money was used years ago in a system known as the barter system (trade using commodities instead of currency). Since commodity money derives its value from what it is made out of, it is quite different to the type of currency that we use today which has no intrinsic value except for what is printed on its face. The following article will provide you with a comprehensive explanation of each form of currency with examples and clearly outlines how they are different from each other.
What is Commodity Money?
Commodity money is very different from the type of currency that we use currently. Commodity money refers to currency that has been created out of a metal or substance that is of value, and therefore carries a value from what it is made out of, as opposed to other forms of currency that have a value printed on its face.
For example, a gold coin is much more valuable than a mere $1 bill since the gold itself as a commodity carries a higher value, as opposed to a $1bill which is worth $1 because of the value that is printed on its face (and not because the paper on which it is printed on is worth anything).
Commodity money is quite risky to use, as it may face unexpected appreciation or depreciation. For example, country A’s currency is made of a precious metal silver, and the demand for silver in the world market falls, then the currency of currency A would experience an unexpected depreciation.
What is Fiat Money?
Fiat money is the kind of money that we use today that is not made of any precious substance and does not carry a value of its own. These forms of currency have been passed through a government tender and do not have any value to itself (intrinsic value). Fiat money is also not backed by any form of reserve such as gold, and since it is not made of any valuable substance, the value of this currency is in the faith that has been placed in it by the government and the people of the country. Since it is printed as legal tender, it is widely accepted.
Fiat money can be used for any payment within the country or region in which it is used. Fiat money is also very flexible and can be used in the payment of a variety of amounts, large and small.
Commodity Money and Fiat Money
Both fiat money and commodity money can be used to make payments, but of the two, fiat money is much more popular and widely used in the modern economy. Fiat money is more flexible than commodity money because it can be used to pay any amount, including even the very smallest amount. This kind of flexibility is not present in commodity money because even small amounts of a precious metal such as gold or silver are worth quite a lot, and therefore cannot be used as easily for paying smaller amounts.
Commodity money can also be perishable items such as farm animals or crop, and in these cases, their value can change because of weather, soil conditions and other factors. Furthermore, the government has more control over fiat money as opposed to commodity money because, if commodity money is in terms of grams of wheat, the country’s farmers would create more of this commodity as they want, creating a very large supply which cannot be controlled. Since fiat money can only be printed by the central bank, there is much more regulation and control.
Summary:
What is the difference between Commodity Money and Fiat Money?
- Both commodity money and fiat money can be used in the payment of goods and services, even though commodity money was used years ago in a system known as the barter system (trade using commodities instead of currency).
- Commodity money refers to currency that has been created out of a metal or substance that is of value, and therefore carries a value from what it is made out of.
- Fiat money is the kind of money that we use today that is not made of any precious substance and does not carry a value of its own.
- Both fiat money and commodity money can be used to make payments, but of the two fiat money is much more popular and widely used in the modern economy.