Comparing Fiat and Gold Money

Fiat Money and
Gold Money
The purpose of this paper to compare and contrast fiat and gold money on econ
and social bases.
2013
Prepared by: Samer Abou Zaghla
10/30/2013

Fiat Money and Gold Money
1
I. Introduction
 Purpose of the paper
 Paper structure
II. What is Money
 Definition
 Emergence of money
 Function of money
 Development of money and monetary systems over time
III. Fiat Money Vs. Gold Money
Comparisons
 Pros and Cons of fiat money
 Pros and Cons of gold money
IV. Conclusion
V. References and Bibliography

2
I. Introduction
Money is considered to be the most important invention by the man kind to carry out trading
and exchanges of goods and services throughout history. The term Money has been used
throughout history to call any object used as means of exchange including gems, commodities,
gold, silver, sugar, food, animal skins, and even cigarettes. Before, inventing money people used
Barter system (the exchange of one good or service for another) in exchange and trading, which
always required what Edgeworth (1881) called a “double coincidence of wants”. The main
problem of the Barter system that it is highly unlikely to always find two persons each have a good
or service that the other demands, which is make it very difficult for any economy to achieve an
efficient allocation of its scarce resources. Whereas, Money makes it easier and more feasible to
trade, since the seller in any transaction will not be concerned whether the counterparty can
produce a useful and precious commodity or service for him. He/she will be pleased to receive the
Money, recognizing that it is acceptable by others in case he/she becomes a buyer in another
transaction. (Wayne E. Baker) For example contended that “Modern money depersonalizes
transactions and disembeds relations”. Money, in this sense, enables production and trading, and
encourages people to work and do their best in the areas of their preferences, consequently, this
will facilitate economic growth and enhances standards of living1
. In addition, money also
endorses personal freedom as stated by (Wayne E. Baker) “Depersonalization permits new levels
of individual freedom. Money, Parsons (1967) argued, grants four freedoms, you are free to buy
what you want, from whom you want, and can accept or reject the conditions under which you
1
This was argued by Ibn Khuldoun before the advent of modern economics discipline (Khaldoun).

3
buy”. The first part of this paper will discuss different types and functions of Money as well as the
development of money and monetary systems over times. In the following part, the paper will
focus on two types of money i.e. Gold and Fiat Money and will establish a comparison between
both in terms of advantages and disadvantages from economic and social angles.
II. What is Money
2.1 Definition of Money:
Money can be defined as an asset that is commonly and socially accepted amongst people to
pay for commodities, services and to pay back loans, “Money is an asset that is generally
accepted as payment for goods and services or repayment of debt” (Cecchetti and
Schoenholtz). In addition, (Mankiw) defined Money as “the set of assets in the economy that
people regularly use to buy goods and services from other people”. Moreover, Money is
considered to be a debt on the society, for example it is written on the dollar “This note is a
legal tender for debts, public or private”, also on old Egyptian pounds it was written “This
note is a debt on the State treasury” .
2.2 Emergence of Money – Introduction
From reviewing the history of money, we can find out that many different objects have been
used as money over times such as, gold, silver, wheat, dates, copper, animal skins, cigarettes,
precious stones…etc. While a number of objects have been used as money, some have
functioned in a superior way than others. Those objects that functioned well, tended to have

4
five fundamental features: (i) durability; (ii) divisibility; (iii) liquidity; (iv) transportability;
and (v) non-imitability. In fact, (Coleman) distinguished money into three types “Commodity
money which contains its value; fiduciary money, which is a promise to pay, and fiat money,
which is less than such a promise”. (Coleman) also suggested that the next stage of evolution
will be ‘Cashless Societies’, where electronic clearing-houses will keep records on debits and
credits rather than having cash exchanging hands.
2.2.1 Kinds of Money:
2.2.1.1 Commodity Money
Commodity money is money that takes the shape of a good and has an inherent value in itself
‘intrinsic value’ such as the six commodities mentioned in the Prophet’s Hadith (PBUH) on
Riba Al-Fadl2
i.e. gold, silver, wheat, barley, dates and salt. Also, contemporary historical
evidence shows that there are other types of commodities that were used as money like in the
war camps of World War II prisoners used cigarettes as money to trade goods amongst each
other3
. Likewise, cigarettes substituted currency in Moscow after “Perestroika” and the fall of
the Soviet Union4
. (Mankiw) Pointed out that “In both cases, even nonsmokers were happy to
accept cigarettes in an exchange, knowing that they could use the cigarettes to buy other goods
and services”. It was also noted that commodity money has been lightly referred to in
Aristotle’s books (350 B.C.) as he suggested that every object has two usages, the first being
the original purpose for which the object was intended, and the second likelihood is to consider
the object as an item to sell or barter. Nevertheless, it is noted that the most common
2
(Kahf, Riba As Described in the Qur'an and Sunnah)
3
(Mankiw)
4
(Mankiw)

5
commodity that was used as money throughout history is Gold. Gold was always a key
component in the international monetary systems throughout history. In fact, Money took the
form of Gold for number of centuries. According to Herodotus, Gold money (gold coins) were
initially introduced on the order of King Croesus of Lydia, in Asia Minor (currently Turkey)
around (550 B.C.), from which it spread rapidly to Greece and then to the rest of the world5
.
Since then Money was issued in the form of standardized coinage. Later the international
monetary system operated under the gold standard, which established a direct tie between gold
and paper money, with paper money being redeemable for gold on request.
2.2.1.2 Fiat Money
In contrast to commodity money, fiat money is a type of money that has no intrinsic value
and not supported by gold reserves, but rather it gains its value from being ordered by the
government and socially accepted by people. (Wayne E. Baker) argued that “Modern money
derive their definitive bundle of traits from the socioeconomic organization of the societies in
which they appear”. All currencies now (including paper, coins and digital accounts) are
considered to be fiat money, and its worth is based on the issuing country economy’s
strength. In fact, the term fiat is derived from the Latin term which means ‘so be it’ thus the
literal meaning of Fiat Money is ‘so be it money’ or ‘money by order’. Some technical
definitions of fiat money are listed hereunder: “A fiat is simply an order or decree, and fiat
money is established as money by government decree i.e. money without intrinsic value that
is used as money because of government decree” (Mankiw). “What is unique about fiat
money is that, unlike gold or silver or some other easily carried “trade” commodity that has
5
(Davies)

6
value in itself (and can, therefore, be traded for other things) printed fiat dollars, in
themselves, are completely worthless. They attain their value only through a social contract”
(Smith). According to Investopedia, fiat money is “Currency that a government has declared
to be legal tender, despite the fact that it has no intrinsic value and is not backed by reserves.
Historically, most currencies were based on physical commodities such as gold or silver, but
fiat money is based solely on faith. Most of the world's paper money is fiat money. Because
fiat money is not linked to physical reserves, it risks becoming worthless due to
hyperinflation. If people lose faith in a nation's paper currency, the money will no longer
hold any value”6
.
2.3 Functions of Money
Money has three main functions in the economy namely:
(i) Medium of exchange/Means of payment: money is used in this sense to facilitate buying
and selling transactions, in the absence of money people would use the barter system.
The main issue with the barter exchange, as highlighted earlier, that each transaction
requires the double coincidence of wants, which has a minimal likelihood to exist and
therefore ends up in an inefficient allocation of the Economy’s resources. Also,
(Cecchetti and Schoenholtz) have argued that people would prefer Money over barter
system since “Money is easier and finalizes payments so no further claims on buyers
or sellers”
(ii) Store of value: Money also is used as a store of value i.e. transferring the purchasing
power between counterparties over different periods of time. Even though money is not
6
www.investopedia.com

7
the best asset to store value, as it depreciates over time in contrast to real estate for
instance, money is the most liquid store-of-value-asset, “Money is the most liquid asset,
but it is far from perfect as a store of value. When prices rise, the value of money falls”
(Mankiw).
(iii) Unit of account: Money also is used to measure the economic-value, determine the
prices of goods and services, and record debts, “A unit of account is the yardstick
people use to post prices and record debts” (Mankiw). Consequently this will enable
market forces to interact efficiently and allocate resources effectively.
It is worth mentioning here that Ibn Khaldoun has a pioneer contribution regarding the
functions of Money theory, and as per many researchers, it is evident that Ibn Khaldoun
put his theory of Value and Prices “Al-Qeima w Al-Athman” way before Adam Smith.
According to the Khaldounian’s theory, Money is characterized by Monetary Stability
“Al-Thabat Al-Naqdui”, which makes it suitable to act as means of exchange as well as
store of value. In addition, Ibn Khaldoun argued that there is a direct relationship between
welfare and prosperity, and the speed of circulation of Money, the higher the speed of
circulation of Money the higher the standards of living and welfare of the community.
2.4 Development of Money and Monetary systems over time
Money and monetary systems have dramatically developed and progressed over time. In
this paper I will focus hereunder on three main stages of this development.
First stage: Emergence of Money with an intrinsic value – Gold coins as an example.
Second stage: Emergence of Paper Money backed by gold – The gold-standard. Third
stage: Emergence of fiat Money not backed by Gold – Nixon Shock.
First: Emergence of Money with an intrinsic value – Gold coins as an example

8
In fact, gold has been used as the money of choice over time, until the emergence of
paper money. The origination of gold coins as money can be traced back to early ages,
precisely to the sixth century B.C. when gold money were initially introduced on the
order of King Croesus of Lydia, as discussed above. Before further discussing the
following two stages, it is worthwhile to review the emergence and development of
Money throughout the Islamic History (from Prophet Muhammad PBUH until the fall of
the Ottomans).
The development of Money and currencies in the Islamic history reveals important
aspects of Islamic communities’ development and cultural heritages as well as showing
how Muslims, who used to be significantly illiterate people before Islam, have been
elevated to a level of advancement and economic development no single civilized nation
attained before in such a very short time. In fact, the pre-Islamic Arabs knew the money
and used it in trading and exchange of goods and services. At the time, Gold and Silver
coins were used as money, gold coin was called Dinar and silver coin was called Dirham,
nevertheless, these coins’ source was the Roman Empire and was not struck by Arabs
themselves. This currencies were the prevailing currencies during Prophet Muhammad’s
PBUH time until the third year of Omar Ibn Al-Khatab’s tenure, when he introduced a
newly struck silver Islamic Dirham and ordered to write on it “There is no God but Allah
and Muhammad is His Messenger”. The biggest transformation in the Islamic Money
development happened in Abdul Malik Ibn Marwan’s tenure. Abdul Malik Ibn Marwan
ordered to mint new Islamic Money inside the country to replace the Romanian coins,
following a dispute that happened between him and the Roman’s King. As a matter of
fact, Abdul Malik Ibn Marwan, struck three types of currency namely, Dinar from Gold,

9
Dirham from Silver and Fils from Copper. Islamic Money continued to take the form of
gold and silver throughout Caliphates times until paper money was introduced.
Second Stage: Emergence of Paper Money backed by gold – The gold-standard
The emergence of Paper Money can be traced back to the eleventh century, when it was
initially introduced by the Song Dynasty of China. The main reason of issuing Banknotes
at the time is that merchants wanted to avoid carrying heavy weights of copper coinage in
big transactions. However, paper money at the time didn’t replace coins, both of them
were being used in parallel. Paper Money then spread and became known to the
European continent around the thirteenth century, mainly by Marco Polo’s Travels
Book7
. The first European paper money were issued by the Bank of Sweden (Stockholms
Banco) during the second half of the 17th
century. These issued banknotes replaced the
metal coins at the time. However, this initiative didn’t succeed and the Bank of Sweden
soon failed and stopped operations because the King of Sweden at the time ordered to
print too much paper money to finance a war, and the bank ran out of the backing metal
coins. On the other side of the European continent there was another initiative, in the
United Kingdom this time. During the 18th
century, the money metal coins were only
issued by the Government, but British people preferred to keep their coins with
goldsmiths for safety purposes. With the increase demand on safety by customers, those
British goldsmiths become bankers rather than jewelers and started to issue bank-notes to
their customers with the value of coins kept with them. If the customer demanded back
their coins, they would present this paper note ‘bank-note’ to the bank to have back the
7
The Chapter about paper money called “How the Great Kaan Causeth the Bark of Trees, Made into Something
Like Paper, to Pass for Money All over his Country”

10
coins to spend them in the domestic markets. When shopkeepers in the local markets sold
their goods and received the coins from customers, they would go to the goldsmiths to
safe keep their coins with them and so on. Shopkeepers instead started to accept the
banknotes, issued by trustworthy goldsmiths, directly from their customers to save the
trip to the goldsmith. Over time, people got used to these bank notes and considered them
a substitute for coins. Consequently, goldsmiths’ vaults became full of gold coins,
obviously, goldsmiths were aware that this gives them a big opportunity for profits by
lending these gold coins (or even lend newly issued bank notes backed by these coins) in
return of interest. This new practice of Paper Money creation by private banks spread
from the UK to other countries in Europe and eventually reached the United States. In the
mid of the 18th
century the gold-standard has emerged. According to the gold-standard
rule any amount of paper money is redeemable for its value in gold by the government.
This was meant to increase the confidence of the newly introduced paper money since it
is now linked to something valuable i.e. gold. Under the gold-standard rule almost all
countries linked their money to a fixed amount of gold, or in some cases linked their
money to the currency of country which did so. Most countries’ economies worked well
with gold-standard until WWI 1914 – 1919, when some nations started to abandon the
gold-standard and printed huge amounts of paper money not backed by gold, to finance
their military forces. For instance Germany put the gold-standard on hold and printed too
much money, which eventually led to hyperinflation to the extent that, the purchase
power of 1 trillion marks in 1923 was equivalent to the purchase power of only 1 mark in
1914. However, the gold standard was restored back after the end of the war, realizing its
benefit to a nations’ economy, until the great depression in 1929 when the US

11
government had to abandon the gold-standard again due to the rush of people trading
their dollars for gold. In 1933 US President Roosevelt instructed American people to
return back their gold in return of US Dollars, and no longer allowed people to redeem
the gold for dollars again, even though it was never officially announced that the US
abandoned the gold-standard. The accumulation of gold by the Federal Reserve made the
American government the largest in holding gold reserves (about ¾ of the world’s gold
supply).
Third stage: Emergence of fiat Money not backed by gold – Bretton Woods and Nixon
Shock
After the end of the WWII biggest countries including USA adopted another system
replacing the classical gold standard – so called Bretton Woods system. In 1944 most of
European countries and the USA signed an agreement in the Bretton Woods conference,
whereby European countries had to fix their currencies against the US dollar (because
USA was the largest holder of gold supply), and the US dollar was fixed against gold in a
rate of 35 dollars to 1 ounce of gold ($35/oz). This system worked very well and the
world economies grew steadily under what so-called the Keynesian policies, until 1971,
when US president Nixon untied the link between the US dollar and gold.
In the year of 1971 the Nixon-Shock announcement has broken the link between the US
Dollar and gold and led to the collapse of the Bretton Woods system. Since this move, all
the world’s important, if not all, currencies became pure fiat money including US
Dollars, Sterling Pound, and Euro.
When fiat money emerged and widely used some commentators started to argue that the
Rabawi-money (money which is subject to Riba) is only the gold and silver money, based

12
on the fact that both types have intrinsic value, whereas the fiat money doesn't have
intrinsic value, and its purchasing power diminishes over time due to inflation.
Nevertheless, large number of prominent Muslim Scholars have rejected this argument,
for instance Sheikh Youssef Al-Qaradwi dismissed this argument in his book "Banks'
Interests is the Forbidden Riba"8
and argued back that "Part of these argument is false
and the other part is true but leads to false conclusion. The false part is to confine the
Cash/liquidity (‫النقدية‬) and Precious/valuable (‫الثمنية‬) characteristics of money to only gold
and silver, and not consider the fact that fiat money has currently become the means of
exchange, the store of value (the most liquid store of value asset) and the tool of saving,
regardless the material from which it is made. In fact, this argument will have a
dangerous implications such as revoking Zakat, which is the 3rd pillar of Islam, and
legalizing Riba, which is one of the biggest 7 sins (‫السبع‬ ‫الموبقات‬)." (‫)القرضاوي‬
III. Fiat Money versus Gold Money
Comparison on Social and Economic basis
3.1 Pros and Cons of Fiat Money
Fiat money is not a scarce resource as gold, therefore, the quantity of fiat money supply is
not limited by scarcity like gold but can be controlled by central banks to serve the
monetary system of a country. In fact, central banks through money supply can control the
economy and effect the society. Also the production cost of fiat money is fractional in
comparison to the production cost of gold money. Fiat money doesn’t have an intrinsic
value, which is viewed as an advantage in some school of thoughts and disadvantage in
other school of thoughts. At one end of the spectrum, some argue that this enables
8
(‫)القرضاوي‬

13
government to print money with little effort and cost to distribute wealth amongst their
citizens. At the other end, some argue that this may induce governments to print too much
quantities of money which leads to hyperinflation and eventually to exacerbate poverty.
However, this notion of ‘intrinsic value’ was criticized by some reporters on the grounds
that value of commodities and money may differ from one person to the other, hence,
nothing has an inherent value, neither commodities nor fiat money, “Paper money, such as
the note above, is sometimes criticized by ‘commodity money’ theorists on the grounds that
it has no intrinsic value. But is there really such thing as ‘intrinsic value’? I would say that
people will value goods and services differently, depending upon each person’s character
and circumstances. Gold may in fact be quite value-less to the producer of goods. Value is
always subjective, never ‘intrinsic’. When people make market exchanges, each gives the
other something they value less at the time in exchange for something they value more.
Gesell argues it is solely its utility in the act of exchange that should give money its value
and that attempting instead to give money an ‘intrinsic value’ is attempting to conjure a
phantom”. (Jones)
On the other hand, many economists argue that the biggest disadvantage of fiat money is its
exposure to devaluation (the decrease in its purchasing power). Many commentators also
argue that fiat money under today’s fractional reserve banking system, induces banks to
create more money, which could lead eventually to inflating the money supply within an
economy. Consequently, this economy will suffer from price bubbles, which always results
in financial and economic crisis.
3.2 Pros and Cons of Gold Money

14
Since gold is a scarce resource then its supply is limited to its scarcity and cannot be fully
controlled by central banks to serve the monetary system of a country, which may have
negative implication on the economic growth. Gold money is not cost-efficient since it
requires a long and expensive production process from mining to coinage, with the
involvement of several production resources such as capital, labor, land…etc. Also, one
of the most important disadvantages of gold money for governments, the restriction it
imposes on their ability of issuing public debt as well as the limitations on credit lines
extension, since a 100% reserve is required in case of gold money. On the other hand,
some commentators suggested that the main advantage of the gold standard its ability to
maintain lower levels of inflation. Nevertheless, it was argued by some commentators
that on the long term this is a disadvantage rather than an advantage. “When money does
not rust, those with money have a store of value immune to deterioration, while those
holding goods do not. Hence those with money will have superior bargaining power to
those with goods. They can wield this advantage in every market exchange, exploiting it
to accumulate more and more money for themselves. Over time then, the “gold-bug
utopia” goes bad – almost all the gold coins end up in the possession of a few people (the
1% you might call them!), who can then exploit their gold monopoly to trap everyone else
into peonage. Producers still require a temporary means of exchange, but this has been
monopolized by the holders of gold to serve as their incorruptible store of ever
accumulating value. So gold must be borrowed at almost any rate of interest demanded
by its lenders. Ironically enough, the Gold Standard advocated by Austrian economist
Friedrich Hayek can itself be “the road to serfdom”!” (Jones). Therefore, it was
contended by the advocates of this argument, that fiat money is more advantageous in

15
comparison to gold money since it devalues over time, which leads to striking balance
between money and the commodities it can buy, and consequently facilitates wealth
distribution amongst different social classes.
IV. Conclusion
Generally speaking, we can conclude that it is proved that money, throughout history, has
increased economic growth, social welfare and standard of living when compared to barter
exchange. In addition, it is noted from historical evidence that barter system was used in
relatively uncivilized simple communities since it required a double coincidence of wants,
while when the man-kind started to become more civilized and transactions became more
complicated, monetary exchange started to be used, whether in a commodity form (like gold)
or in fiat form. It was also observed that money and monetary systems have been evolved
dramatically over time from commodity money to fiat money. In fact, this evolvement had
number of implications on man-kind from both social and economic standpoints as
highlighted earlier. Fiat currency now can be viewed as a social custom supported by
government rather than economic relationship.

16
Bibliography
Cecchetti, Stephen G. and Kermit L. Schoenholtz. Money, Banking and Financial Markets. McGrew-
Hill/Irwin, 2010.
Coleman, James S. Foundations of Social Theory. Cambridge: Harvard University Press, 1990.
Davies, Glyn. A History of Money from Ancient Times to the Present Day, 3rd ed. Cardiff: University of
Wales Press, 2002.
Jones, David A. "Positive Money." 14 March 2012. Positive Money Web Site. Document. 1 October 2013.
Josh Ryan-Collins, Tony Greenham, Richard Werner, Andrew Jackson. "Chapter 3. The nature and history
of money and banking." Josh Ryan-Collins, Tony Greenham, Richard Werner, Andrew Jackson.
Where Does Money Come From? London: New economics foundation, 2011.
Kahf, Monzer. "Islamic Finance: Business as Usual." 25 September 2006.
—. "Riba As Described in the Qur'an and Sunnah." 1997.
Khaldoun, Ibn. Muqademat Ibn Khaldoun. 1377.
Mankiw, N. Gregory. Principles of Economics. 2009.
Smith, Devin. "The strange reality of fiat money." (2013).
Wayne E. Baker, Jason B. Jimerson. "The Sociology of Money." The American Behavioral July/August
1992: 678. Document.
‫,القرضاوي‬ ‫يوسف‬ ‫.الشيخ‬ ‫المحرم‬ ‫الربا‬ ‫هي‬ ‫البنوك‬ ‫فوائد‬. ‫,الدوحة‬ n.d.

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