Fiduciary money is the term used to refer to money made up of valid banknotes and coins in circulation in a given country. Its value is based on the trust of its users and not on the cost of its manufacture.
For example, a €20 note has a value of €20, not because of the costs associated with its manufacture, but because its users see it as a €20 note that allows them to acquire a product or service of the same value.
Contrary to what one might be tempted to believe, fiduciary money represents “only” 15% of the money supply. To learn even more, here is our complete guide to bank notes and coins.
Currency is a payment instrument used on a daily basis. Above all, it should be noted that it has existed as long as the currency itself (it is as old as transactions involving the payment of a certain consideration to obtain a given product). Its legal value is guaranteed by the State and users believe in it: it is all a matter of trust.
Currency includes coins and banknotes that circulate in a country. Deposit accounts (and therefore the associated cheques) are also included. The value of the medium (paper or other) is not taken into account at all. Over time, confidence has strengthened and the benchmark currency has eventually disappeared. Now, users have complete confidence in the number that is written on a currency: 10 euros is worth 10 euros, nothing more, nothing less.
Today, most of the world’s currencies are fiduciary currencies. The euro is one of them (whether it is coins or banknotes). If the nominal value of each euro remains the same as the one written on the support, it may be affected by inflation. In any case, this currency is valid in 19 of the 28 Member States of the European Union. It is used by nearly 338.6 million people.
A brief look back at Bretton Woods
In referring to fiduciary money, one cannot fail to mention Bretton Woods, which marked a real turning point in the history of fiduciary money. As mentioned above, this type of currency has almost always been used, but under different conditions. Everything changed in 1944 with the famous Bretton Woods conference.
First, it should be remembered that before 1914, there was talk of a “gold standard”. It was on this reference that most currencies in the world were based. The gold standard then made a significant contribution to the development of international trade, which could be achieved with confidence between the operators concerned. But the First World War, and then the stock market crisis of 1929, changed the situation. In particular, it has become difficult to preserve sufficient gold reserves to distribute currency. This situation was particularly inextricable for countries with a negative trade balance, such as the United States. It is indeed necessary to underline the impact of importation: the currency leaves the country (and therefore the gold).
Returning to the Bretton Woods conference in 1944, it led to the establishment of a dollar-centred economic system. The latter then becomes the only currency that can be exchanged with gold. As for the other currencies, they inherit the “fiduciary” character while being convertible into green notes. From that moment on, the dollar replaced gold as the reference currency.
It was not until 1971 that another upheaval took place. U.S. President Nixon decides to suspend the possibility of converting the dollar with gold. This is how most of the world’s currencies become fiduciary.
Gold is no longer the reference
With the advent of currency, gold is no longer the reference. As a reminder, in the past, any currency that was not made of a valuable metal could be exchanged for gold. At that time, a bank note was more like an acknowledgement of debt. This “document” could then be converted into gold at any time according to the needs of its owner. This then gives some confidence to the banknote in question.
Today, this trust still exists, but it is no longer possible to trade with gold. And then we got used to the bodies that issued the currency in question, which is none other than the banknote currency.
The nominal value of the banknote currency
The nominal value of the currency corresponds precisely to the entry on it. Thus, for a 20 euro banknote, “20 euros” is taken into account. No other parameters are taken into account. This ignores the cost of the medium (paper) and the cost of manufacturing.
In comparison, this principle does not apply to monetary instruments based on precious metals: here, the value of the support is very important. Moreover, for banknotes and coins, the medium is worth practically nothing if you compare it with its face value (if you take the example of a 500 euro banknote, for example).
When it comes to fiduciary money, trust is essential: the user believes in it. When he has a 20 euro note in his hand, he knows that he can use it to acquire a product or service worth exactly that price.
Note that if the face value of the currency remains the same, its exchange value may fluctuate. To avoid this negative effect, the State must take various measures. In particular, the currency disseminated must not exceed all its resources. If so, a decrease in the exchange value is to be feared and inflation may occur. More precisely, this results in a decrease in the purchasing power of users.
The State, guarantor of the value of banknotes and coins
For users to have full confidence in the currency and for it to play its role as an exchange instrument, it is necessary for an entity to guarantee its value. It is mainly the State, but not only the State. Other authorities also contribute, such as the central bank, the city or groups of traders.
Due to the particularities of fiduciary money, a distinction must be made between legal tender and forced tender. On the one hand, it is impossible to refuse a fiduciary currency. On the other hand, there are still constraints to be respected when its support is dismantled and the currency is therefore not in the form of coins or banknotes. Ultimately, it must then be taken into account that fiduciary money is an integral part of a whole called the “money supply”.
This money supply includes several other payment instruments, including electronic money (which, by the way, is becoming increasingly popular).
The use of banknotes and coins: advantages and weaknesses
At the outset, it should be stressed that the emergence of currency has solved many practical problems. The existence of different types of currencies (coins and banknotes) reduces congestion. Depending on the needs of each individual, it is possible to provide only the essentials. Thus, there is no need to transport 500 1 euro coins since there is a 500 euro version. The practical side is undeniable.
Then there is confidentiality and anonymity. Each coin and banknote can change ownership without constraint, and this, without changing value. This is not the case with other “bearer” means of payment, i. e. which cannot belong to the person whose name is entered on the means of payment in question: this is a nominative system and which very often implies the impossibility of transferring the amount concerned to a third person.
On the boundary side, there is first of all the risk of devaluation of the currency, depending on economic and political conditions. It should also be noted that it is still possible for the currency to be replaced by new editions, not to mention the physical risks: loss, theft or fire.
Finally, it should be stressed that the possession and use of banknotes and coins may be subject to specific rules depending on the country, the objective being most often to combat money laundering.
Trusting bank notes and coins
When it comes to fiduciary money, we often refer to it as “trust”. It should be stressed that this is not a matter of blind trust. If, today, any coin or bank note inspires direct confidence (as long as they are not counterfeit!), there has necessarily been a beginning. Originally, various measures had to be put in place to ensure that everyone could use cash with complete peace of mind.
First of all, we must mention the State, a solid institution. It is important that the latter accepts a given currency so that his or her due can be returned using the currency in question. Here, it may also be an economic operator. This acceptance gives value to the currency.
Next comes legal tender. Fiduciary money can be legally used for various transactions, whether by economic agents or individuals. Here, there is a priori no risk of refusal of payment as the money received can be used (indefinitely) to make new purchases (and so on). On the other hand, it should be noted that the currency is not automatically convertible to another currency or material knowing that some currencies are stronger than others. Among the “strongest” ones are the euro, the dollar and the pound sterling.
Finally, account must be taken of the interest rate that applies to bonds valid for a particular currency. Confidence is preserved when this rate exceeds inflation. If this is not the case, a depreciation is possible.