Money is the most fungible economic instrument man has ever invented and we have taken it for granted.  With money, one can exchange anything of economic value. There is nothing that money can’t buy, so goes the saying. Everyone knows that paper money is issued by the State.  Therefore, it must also be the state that assigns value to the money that we have in our pocket. The important question is what enables the state to assign a fungible economic value to a piece of paper? What is the economic principle behind it? Whether there is any law involved in such a process? Whether human psychology has something to do with it? The answer is everything. To understand money, we must analyze it at the three different domains of knowledge mentioned above.

What is the economics behind paper money? The most accepted economic theory of money is the credit theory of money.  According to the credit theory of money, the first human economy operated on the basis of credit and not barter as Adam Smith had made us believe. The barter theory of money has been discredited due to a lack of archaeological and anthropological evidence. It doesn’t mean the barter system never existed but it was preceded by a credit system of economic exchange or otherwise known as the gift economy. According to the latest consensus in economics, anthropology, and archaeology, ancient humans gifted or credited any goods or services to another human being upon demand and the recipient of such benefit of goods or services will be obliged to give any goods or services which the provider of such benefit may want or need in the near future.  For instance, Person X catches fish and shares the same with Person Y where Y doesn’t have anything of value that X may require at the moment. Person X may credit the fish he caught to Y as a gift or credit and Y may reciprocate by providing something that Y may have in the near or distant future and X may want. For Example, Y collects a bunch of tender coconuts that X wants to consume and Y obliges X to satisfy the credit he owed to X for the fish two months back.

In a community of human beings who is living to gather, goods and services may be gifted to each other whenever such goods or services are needed and are made available as gifts. This stage of human economic interaction was known as primitive communism according to Karl Marx.  When human societies evolved into small human settlements at the banks of major rivers after the invention of agriculture, human beings in such settlements began to track what each of them has credited and to whom. The use of rare stones from Dimond to Gold was being used as a marker which reminded someone of a credit owed to him /her by someone else. When the person from whom credit for any goods or services is owed in the past, the same started to be marked or evidenced by a rare stone held by the holder of such credit who can redeem such credit by demanding something that the debtor may acquire in the present or future which the creditor may need or want or the alternative option for the creditor is to exchange the rare stone marking the credit he owns to a third party who may have in his/her possession any goods or services such creditor may need passing the credit to a third party who may present that same rare stone back to the original debtor in the future or present to claim any goods or services that the original debtor in his possession as redemption.  These credit economic transactions were as successful as modern-day money in aiding the fulfilment of economic transactions. The rare stones which were used for marking the crediting of goods and services became a very precious commodity in themselves having economic fungibility equal to that of money.

Eventually when human economic interactions became more complex carrying these markers of credit in the form of rare stones and metals become inconvenient. With the invention of paper in the seventh century ancient China, a solution was devised where through the institution of the state, all rare stones and metals marking a credit for any goods or services were represented in the form of the paper with intricate symbols and designs of the State which were designed so as to make it difficult to replicate and any action or attempt to replicate the paper or to destroy the same without the sanction of the state were made punishable by law. Hence the modern paper money was born. The value of the paper money was backed by rare stones and metals like gold and each paper money can be exchanged for an equivalent value of rare stones like diamond or metals like gold.

In 1861, just like in Ancient China, Treasury Secretary Salmon Chase printed the first U.S. paper currency following the enactment of the Gold Standard Act which established gold as the only metal for redeeming paper currency. It set the value of gold at $20.67 an ounce. This stage of the evolution of money is most popularly known as the Gold Standard. In order to standardize economic transactions in the world economy increasing number of other countries soon adopted the Gold Standard along with the U.S. America soon became the holder of the biggest reserve of Gold in the world. The reserve of gold was significant enough for most countries to back their own currency with the U.S dollar instead of gold. The Gold Standard was cemented in international law after II World War through the Britton Wood Agreement in 1944.

The Gold Standard came to an end in 1971 when the then U.S President Nixon ended the Gold Standard by de-pegging the U.S Doller from Gold through the powers granted to the U.S President under Economic Stabilization Act,1970 due to increase in trade deficit suffered by the U.S against a depleting gold reserve and increasing inflation rates. This unilateral action also led to the collapse of the Britton Wood Agreement and the end of the Gold Standard. This event in history was popularly known as the Nixon Shock. Post Nixon Shock created a new currency known as a Fiat Currency or Fiat Money. Fiat in Latin means it shall be done or let it be done.  Fiat money is a money that is not backed by any tangible substance of value like rare stones like diamond or rare metals like gold but rather it is backed by the intangible sovereignty of a state which is issuing such a fiat currency.  The value of a Fiat Currency depends upon the political, social, and economic stability exhibited by a country issuing such a fiat currency.

The Country issuing a fiat currency need not worry about inflation in the value of the currency due to lack of supply of gold or precious stones to back their currency or about their price fluctuation due to demand and supply. Any number of Fiat Currency can be printed by a country as long as it has a strong and stable socioeconomic and political order sustaining its sovereignty under international law. United States is located in one of the safest geographical locations in the world, enjoying relative economic growth, along with political and social stability in the world which are indicators of a strong sovereign nation entailing the U.S Doller as one among the strong fiat currencies in the world. Just like the U.S and the majority of Nation-States in the world, India also has a fiat currency after the economic reforms of 1990. Under Section 22 of the Reserve Bank Of India Act, 1934 only the Indian Reserve Bank has the power to issue currency notes of various denominations and in each and every Indian Currency Denomination the Indian Governor is Promising to Pay the Bearer the sum of rupees represented in the note. It does not promise to give any amount of gold in exchange for the sum of rupees represented in any Indian currency notes, which is an essential feature of currency running on Gold Standard.  The promise of the RBI Governor is therefore backed by the strength and sanctity of Indian Sovereignty evidenced by its economic, social, and political stability and advancement. Any social or economic or political uncertainty with regard to a Nation-State entails weakening of its sovereignty and to the devaluation of its fiat currency. Therefore, the fungible value of a modern currency is derived from the law enacted by a modern sovereign state and not backed by any rare or valuable stone or metal as one may think.