8 — Fiat Money and Modern Monetary Systems (20th Century)

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Part D — Gold Standard and Fiat Money

The 20th century marked the transition from gold-backed currency to fiat money, where government-issued currency derives value primarily from public trust and legal decree rather than physical commodities. This shift enabled greater monetary flexibility and the development of modern financial systems.

Economic Context

  • World Wars I and II disrupted gold reserves, forcing countries to suspend gold convertibility.
  • The Bretton Woods Conference (1944) established a post-war monetary order:
    • The US dollar became the primary reserve currency, convertible to gold.
    • Other national currencies were pegged to the US dollar.
  • By 1971 (Nixon Shock), the United States ended dollar-gold convertibility, fully transitioning to fiat currency.

Characteristics of Fiat Money

  • No intrinsic commodity value: Value is socially and legally assigned.
  • Government-backed: Legal tender enforced by state authority.
  • Flexible money supply: Central banks can expand or contract currency issuance to manage the economy.
  • Unit of account, medium of exchange, store of value: Functions are maintained through public confidence and regulatory frameworks.

Key Innovations and Developments

  1. Central Banking and Monetary Policy
    • Central banks, such as the Federal Reserve (1913) and Bank of England, implemented tools for interest rate adjustment, reserve requirements, and open market operations.
    • Enabled systematic control of inflation, unemployment, and economic growth.
  2. Electronic Payments and Banking Technology
    • Introduction of credit and debit cards in the mid-20th century.
    • Automated Teller Machines (ATMs) in the 1960s increased access to cash and reduced dependence on bank branches.
  3. International Monetary Systems
    • Post-Bretton Woods: currencies floated against each other; exchange rates influenced by market dynamics rather than gold reserves.
    • Enabled greater capital mobility and global trade expansion, but introduced currency volatility.

Economic and Social Impacts

  • Economic flexibility: Governments could respond to recessions and crises with monetary stimulus.
  • Financial innovation: Facilitated consumer credit, mortgage lending, and complex financial instruments.
  • Globalisation: Fiat systems underpinned the expansion of international trade and investment.
  • Dependence on trust: Public confidence in fiat money became critical; hyperinflation in some countries (e.g., Weimar Germany) demonstrated risks.

Significance

  • Fiat money allowed the modern financial system to expand beyond physical constraints.
  • Central banks emerged as key regulators, balancing currency stability with economic growth.
  • Paved the way for digital finance, electronic payments, and later cryptocurrency innovations.

References

  • Bordo, M. D., & Schwartz, A. J. (1999). A Retrospective on the Bretton Woods System. Chicago: University of Chicago Press.
  • IMF (2021). The Bretton Woods System at 75. Washington, DC: International Monetary Fund.
  • Pistor, K. (2019). The Code of Capital: How the Law Creates Wealth and Inequality. Princeton: Princeton University Press.
  • Davies, G. (2016). A History of Money. Cardiff: University of Wales Press.
  • Eichengreen, B. (1996). Globalizing Capital: A History of the International Monetary System. Princeton: Princeton University Press.
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