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Commodity money vs. Fiat money

A brief look at how money has evolved over time from being printed on valuable substances (commodity money), to merely representing those valuable substances (commodity-backed money), to not representing anything at all (fiat money). Created by Grant Sanderson.

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  • blobby green style avatar for user amanjain.mnit
    At ,The tutor says that the commodity money is also representing faith and trust which is also true for Fiat money .But my main problem with this notion is that the government can print it as much as fiat money as it wants. But the amount of gold and silver can't just be produced just like that, there value is derived by demand and supply where supply can't be unlimited unlike Fiat money. How can tutor say that in a way both of them are same? Can someone explain ?
    (11 votes)
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    • leaf green style avatar for user Paul Tabor
      The commodity money is also prone to drastic changes in value, for example when there is a sudden increase in supply. That has happened in history, for example when first conquistadors returned to Europe with lots of discovered gold and silver (Spanish Price Revolution).
      (5 votes)
  • blobby green style avatar for user marcelovitor.pereira
    I understand the difference between Fiat and Commodity currency, but what are the arguments for and against it? There are many who contend that the Gold Standard maintains the inflation stable, but leaving the Gold standard was a way found to avoid depressions like that of 1929.
    (1 vote)
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    • starky tree style avatar for user melanie
      I think you answered your own question! :)
      The arguments for a gold standard are that it makes it much harder for inflation to occur, but the argument for fiat money is that it is much more flexible and makes growth easier.

      Gold creates a fixed money supply, so if you have more output, but the same amount of money chasing that output, then it makes it difficult to buy or sell that new output if your money supply cannot also adjust.
      (6 votes)
  • piceratops seed style avatar for user James Carmody
    An irrational economy actor would likely exchange good fiat money for gold and silver, would they not?
    (2 votes)
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  • female robot grace style avatar for user bulljayt0311
    On the topic of commodity money (starts at ) I have three questions:
    1. Why does it have to be gold or silver? With so relatively few amounts of gold or silver, there wouldn't be enough of those metals for governments and people to spend on goods and services. Why not something like oil?
    2. Could we consider Bitcoin as commodity money, where electricity is the commodity?
    3. Did the Tulip mania of 1637 in Europe have anything to do with commodity money? If it does, what did we learn about commodity money from that incident?
    (1 vote)
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    • blobby green style avatar for user marcelovitor.pereira
      1. As mentioned around , the backing commodity is not always gold or silver. The shekel was backed by barley. The backing commodity has to represent something people value in and of itself. Gold satisfies this criterion for western modern societies.
      2. You cannot go somewhere and exchange your Bitcoins for electricity, like you could exchange the Dollar bills for actual gold and silver. I mean, you can purchase things with Bitcoin, including electricity, but it is not fundamentally backed in electricity by the government, so there is no guarantee you can do so.
      3. The price of a specific product might increase whether or not the unit of value is linked to a commodity money or not. The high-price of tulips is for sure a smaller example of the effect of people's psychology in the economy, but it just affected tulips. That is, what value people assigned to tulips was overestimated based on what value they thought they could sell it for.
      (2 votes)

Video transcript

- [Voiceover] Let's take a look at a United States one dollar bill. What is it that gives this thing value? You can give it to people and get back, ya know food that you can eat, or things that you can use, and things of hard value. But what is it about this little piece of paper that makes it valuable? Or I guess it's not paper, as it's cotton, something like that, right? But the questions stands, right, like what makes this flimsy little thing, that doesn't seem to have any use in it's own right, valuable? Well, one kind of interesting exercise is to step back in time a little bit and take a look at what the very, very first United States dollars looked liked. So I have here one of the very first that was printed, and let's zoom in on it and kind of read some of the words associated with it. So if we zoom in, let's just say towards the very top here. Notice that it says silver certificate, silver certificate up at the top. So what does that mean? Well, if we zoom out a little bit, it says, it says that this certifies that there has been deposited in the treasury of the United States of America and then the sentence kind of continues in an awkward way below, one silver dollar payable to the bearer on demand. So what that means, what this dollar originally represented was the fact that you were gonna be able to turn in this bill for a silver dollar. This piece of paper in theory, could be turned in to the United States treasury, which guaranteed that it had in its deposits a silver dollar, an actual piece of silver, and I'll show what one of those looked like in just a moment, It would return to you for this bill. So in a sense what gave it value was this guarantee that you could turn it into silver if you wanted. So this way you could trade this with other people as if it were a piece of silver, 'cause if you gave it to someone that person, now being the bearer on demand, could then in theory, turn this in and get a silver dollar as a result. And the reason for even having this paper money, and printing these bills is that it was pretty inconvenient to always lug around actual pieces of silver, and actual pieces of metal. And this would be especially true in the case of even higher amounts. So for example, here we have a 10,000 dollar bill. Something you don't really see too often. And if we zoom in and kind of see the guarantees that are written on this guy, it's actually very similar, but its this is instead in gold instead of silver. It says that $10,000 in gold are payable to the bearer on demand, as authorized by law. So kind of legally backing up the idea that this could be turned in for $10,000 worth of gold. So that way people could actually treat this as if it was, ya know $10,000 worth of gold, without having to lug around that much money. So what is it that you actually got when you turned in, ya know for one silver dollar or something like that. What is it that was payable on demand? Well you have, what's another form of money, what you can use in commerce and kind of trade with people as a medium of exchange. Officially United States money, but the difference is that the piece of money itself, is the valuable metal. It actually is the silver, so in theory if you ya know, didn't trust the United States Government anymore, you could melt it down for just the pure silver and maybe other countries still value that silver. And similarly there was gold coins like this that people would use. Like this right here is a gold coin worth two and a half dollars. So, this is something where the value is held within it because presumably people value gold, and even if this didn't have a fancy you know, United States symbol all stamped onto it, it would be something valuable, because it's gold. And this kind of money, this ya know gold coins or these silver coins has a special kind of name. It's called commodity money. Let's see, commodity money. And basically what this means is that the thing that you're using for money, the thing that you're trading around, has some value in it's own right. Even if it wasn't money, it would still be something valuable. This word here, commodity, basically means just anything valuable, it could not only be ya know silver or gold, but things like food or furniture or livestock. These are commodities. And you know you could argue that silver and gold aren't valuable other than the fact that people just like using them for trading. I mean they're kind of pretty and useful for jewelry, and there's some electronics that use them, but on the whole, the main reason that people value silver and gold is because they're used for trading. It's kind of because other people value them. So it's a little bit weird that these are the quintessential examples of commodity money, when in fact other commodities ya know like wheat or oranges feel much more real, hard valuable, something you can use in its own right, than the pieces of metal. But never the less, these are, these are commodities. And the other form of money here, where you have something that you could in theory exchange to a bank, and then the bank would return to you, ya know the actual silver that it represents, the commodity that it represents, ya know in this case silver. These are called commodity-backed money. Commodity-backed. Because their value is being backed up by the value of whatever commodity they represent. Another term that you might hear for them is representative money, because they are representing another good, representative. In this case, silver or gold. But in the early days of money, like thousands of years ago, you would have representative money like the shekel, which represented a certain weight of barley. So it doesn't just have to be silver or gold, sometimes you have money that represents a different sort of commodity, so commodity-backed, representative. This is the kind of old style United States, or other countries money. A lot of people had commodity-backed money. But in modern terms, it's common not to have either of those. You can just have this bill that's not backed up by silver. You could not turn this in and get silver as a result. And this, this is termed fiat money. Fiat money. And this word fiat kind of means a decree or a declaration, so it's like the United States Government has declared that this is money. And just by declaring that it's money, presumably that gives its value. So it kind of feels much more hollow in comparison to commodity money, or commodity backed money. But there's a couple, a couple hard things backing this up. One of them, if we kind of zoom in on some of the words here. If you go you see that it says this note is legal tender. So here, I'll write that down. This note is legal tender for all debts public and private. And I talked about the idea of legal tender in the last video and how that actually ya know gives a little bit of clout to this being valuable as long as you trust that the government will enforce it's laws, as it claims that it will. But for the most part, what makes this stuff valuable is the fact that other people trust it, right? The reason that you value having a dollar bill is because you know you can give it to most people and they are willing to trade you valuable things for it. And at the end of the day, that's what was making, ya know silver dollars or these $10,000 ya know gold notes valuable. 'Cause almost no one would actually trade it in for the silver, 'cause why would you? It's just as good, and it's a little bit more convenient to just trade around the bill itself. So once that's actually in the psychology of a society, and once everyone kind of is used to the idea of trading around this paper representative money in order to get things of value, it's not actually a huge leap to just have the paper that you're trading around as long as everyone else trusts it. And it still serves those functions of money that I talked about in previous videos. It's a medium of exchange, and you can store this for value, right? The paper's not going to degrade, it's something you can store, and it does give a unit of value. Assigning a number to various goods out there. But it is, it is just something that was declared, it's not an actual hard good, and this is kind of an important distinction to recognize is that fiat money really does mean it's just trusted, it's just taken on faith that people will find this valuable. But for that matter, that's also true of silver and gold, right? Like, it's just taken on faith that if you melted down the silver other people would find that valuable. And same goes for gold, and in fact in some, ya know even though a lot of western cultures valued gold a lot, there were other cultures that they might find like in Asia, that didn't value gold in the same way. And just thought why is everyone getting all up in a fuss about this fancy metal? So this idea of having money that we use basically because we trust that others will find it valuable, isn't actually that absurd, and as long as it serves the same three basic functions of money, you can have a working society. Ya know barring things like hyperinflation, that makes it so that it no longer serves those functions of money. See you next video!