Fiat Money
Money that has value because a government says so and people accept it, not because it can be exchanged for gold.
Fiat money is money that is worth something because a government says it is and everyone else goes along. It cannot be exchanged for a fixed weight of gold or silver. A ten-dollar bill is a piece of cotton and linen whose only promise is that the United States will take it for taxes and that the shop on the corner will take it for lunch. Every major currency in the world has worked this way since 1971. The name comes from the Latin for let it be done.
China tried it first, and it went badly
Paper money began in China. Song dynasty merchants were using printed notes by the eleventh century, and later dynasties turned them into state currency. The Ming issued the Da Ming Baochao from 1375 and made the two mistakes that became the standard lesson: the notes were not redeemable for anything, and the government did not take enough of them back in taxes, so the supply only ever grew. Within a few decades they were worth a fraction of face value. China abandoned paper and ran on silver for the next five hundred years.
Europe repeated the experiment. The American colonies issued Continentals to pay for the Revolution and printed so many that not worth a Continental became an insult. Revolutionary France issued assignats against confiscated church land and inflated them to nothing. The Confederacy did the same. Each collapse pointed at the same conclusion: paper works only if somebody keeps it scarce, and governments fighting wars never do.
How the world ended up here anyway
Metal has its own problem. Under a gold standard the money supply depends on how much gold has been dug out of the ground, which has nothing to do with how much money an economy needs. When a slump arrives, gold forces the opposite of what is required, meaning higher interest rates and falling wages. The countries that left gold earliest in the 1930s recovered earliest, which is the single most persuasive piece of evidence in the whole argument.
Convertibility was suspended in the First World War, restored badly in the 1920s, and largely abandoned in the 1930s. Bretton Woods after 1944 was a partial version, with other currencies fixed to the dollar and the dollar convertible into gold at 35 an ounce, for governments only. By 1971 there were far more dollars held abroad than gold in the vaults, and on 15 August 1971 Nixon closed the window. That was the end of metal money.
What actually backs it
Three things, none of them a vault. Taxes, because the state demands payment in its own money and everyone therefore needs some. Legal tender laws, which are the weakest of the three. And a central bank willing to keep the currency scarce, which is why central bank independence and inflation targeting, invented in New Zealand in 1990 and copied almost everywhere, became the standard design.
When the third one fails you get hyperinflation, and it is always fiscal. A government that cannot borrow and will not cut spending prints instead. Weimar Germany, Zimbabwe, and Venezuela are the same story with different decades.
The advantage of fiat is that a central bank can act. The financial system was kept breathing in 2008 and again in 2020 by central banks creating money on a scale no gold standard would have allowed. The disadvantage is that the same power is available to a government that wants to spend without taxing.
That argument never really ends. It came back with the inflation of 2021 to 2023, the first serious test of the system in forty years, and it is what the gold bugs and the Bitcoin advocates are actually arguing about. The dispute is not really about technology. It is about whether anybody should be trusted with a printing press.