Fiat money

Look at a hundred-rupee note. It promises you nothing physical. You cannot take it to the Reserve Bank and demand gold for it.

So why is it worth anything?

Because the government says it is money, and everyone accepts that. The word fiat means an order. Fiat money is money that is used because a government orders that it must be accepted as payment.

Its value comes from two things. The first is the relationship between supply and demand for it. The second is the stability of the government that issued it. What it does not come from is the worth of any commodity sitting behind it.

This is not an exotic case. Most modern paper currencies are fiat currencies, including the US dollar and the euro. In the United States the dollar is fiat money. In India, the rupee is.

The gold standard was the opposite arrangement, and fiat money replaced it completely.

The workbook's definition. Fiat money is a government-issued currency that is not backed by a physical commodity, such as gold or silver, but rather by the government that issued it. Its value is derived from the relationship between supply and demand and the stability of the issuing government, rather than the worth of a commodity backing it.

How the rupee fits. Chapter 1 gives the Indian machinery:

• The rupee is the official currency of India and is subdivided into 100 paise.
• Issuance of the currency is controlled by the Reserve Bank of India.
• The RBI derives its role in currency management from the Reserve Bank of India Act, 1934.
• The rupee has a market-determined exchange rate, but the RBI trades actively in the USD/INR market to influence effective rates — a de facto controlled rate, sometimes called a managed float.

The handover from gold. The gold standard was completely replaced by fiat money. Britain stopped using the gold standard in 1931, the US in 1933, and the US abandoned the remnants in 1973. No government uses the gold standard today.

Why a currency paper teaches this at all. If money were still a claim on gold, an exchange rate would be arithmetic and there would be nothing to hedge. Because every major currency is fiat, its price against every other currency is set by supply, demand and confidence — which move every day. Fiat money is the precondition for a currency market, and therefore for currency derivatives.

Note the limit of what the workbook claims: it does not give any figure for how much fiat money is in issue, or any rule capping it. The passage is definitional, and a candidate should not expect a number from it.

Two notes, two kinds of promise. The gold figures are the workbook's; the rupee rate is its own worked level of 83.

What that costs an exporter. A Coimbatore garment exporter invoices a US buyer USD 100,000, payable in three months.

The spread between the best and worst of those is Rs 3.50 lakh on a single order, and it exists purely because both currencies are fiat. Under a gold peg the three rows would be identical. This is why the exporter hedges: at USD 1,000 a USDINR contract, the exposure is 100 contracts.

Chapter 1, section 1.1, defines fiat money in the same passage that ends the gold standard, and section 1.2.1 (Indian Rupee) supplies the RBI Act, 1934 and the 100-paise subdivision. Questions are recall-shaped: what backs fiat money, which currencies are fiat (dollar, euro, rupee — all of them), and whether any government still uses the gold standard. The trap version asks what gives fiat money its value, with "the gold held by the central bank" sitting there as an answer.

• Fiat money is not backed by a commodity. The backing is the issuing government itself.
• Its value rests on supply and demand plus the stability of the issuing government — not on reserves of gold.
• The rupee, the dollar and the euro are all fiat money. There is no exception among the majors.
• Fiat replaced the gold standard entirely. Do not answer that the two run side by side.
• Fiat money does not mean an unmanaged rate. The rupee is fiat and market-determined, yet the RBI intervenes actively — the workbook calls the result a managed float.
• "Fiat" describes what backs the money, while "clean float" or "managed float" describe how its rate is set. A question can test either, and they are different axes.