Money must be Acceptable

Something can function as money only if people are willing to accept it as money. It is not impossible to imagine a world where chocolate chip cookies function as money. If everyone else is willing to accept cookies in payment for goods and services, then you will be willing to do so as well. But if other people accept only printed pieces of paper as money, then you would be foolish to accept chocolate chip cookies for the product that you sell. Fiat Money We know of no country, of course, that actually uses chocolate chip cookies for money. In most countries, money takes a particular form called fiat money. Fiat money is money that is not backed by any physical commodity, such as gold. Instead, the currency is intrinsically useless pieces of paper that attain value in exchange. Fiat is a Latin word that means “let it be.” Fiat money is money just because the government says so. In a fiat money system, the government does not promise to exchange goods for money. In addition, money is not generally something that we can directly consume: most people would not enjoy eating a dollar bill. So if it doesn’t taste good and the government doesn’t promise to give you something in exchange for it, what gives fiat money value? Why are we all willing to work hard to get pieces of these—intrinsically worthless—pieces of paper? The answer is because these pieces of paper are acceptable as money. Other people will accept them, so you and I will as well. To put it another way, fiat money has value because everyone believes it has value. Think back to the story with which we opened the chapter. The US economy uses green and white pieces of paper as money. US residents are willing to give up valuable goods and services in exchange for these green and white pieces of paper because they believe that others, in turn, will accept them. Such an arrangement sounds fragile, and it is. If everyone stopped believing that fiat money had value, this would be a self-fulfilling prophecy.