What does it mean for a currency to be backed by something?
In: Economics
A currency is “backed” when the government guarantees your right to exchange currency for a specific amount of “something”. If the US dollar was “backed” it would mean every single dollar could be exchanged for a certain amount of “a thing”. That thing can vary but historically it was either silver or gold. The system is called “silver standard” or “gold standard” accordingly. The United States used to have a “gold standard”. Meaning every amount of US currency could, in theory, be traded in, on demand, for a certain amount of gold.
Which of course meant the US had to sit on amount of gold to have available to be so traded in. We did! We still have it. You’re probably heard of it. Ft. Knox is where the US stored most of the gold it kept “on hand” to satisfy any legal demand.
Countries have by and large moved away from “backed” currency to what is called “fiat currency” for various reasons probably more complicated than suitable for ELI5. Suffice to say in a fiat system money is worth exactly what it is worth. One US dollar is worth precisely one US dollar. how much is a dollar worth you might ask? Well you see, it is worth precisely $1.
If this seems circular it’s because it is. Because in a fiat based currency system, money is worth exactly what people agree it’s worth. if $1 buys you a can of soda then $1 is worth a can of soda. If it buys you a car then $1 is worth a car.
The scariest thing about studying economics is the slow dawning realization that money is fundamentally made up and is worth only what we all sort of collectively decide what it’s worth. It’s worth exactly what we say it is, no more no less.
And the most terrifying part of that is theoretically nothing stops everyone from waking up tomorrow and deciding it’s worth nothing.
Sometimes currency has no value because no one has faith in the government monetary policy…..printing trillions of dollars with nothing to support the value (Zimbabwe, Venezuela )
So the government can back/support the currency by having alternative assets in reserve
For many countries this is a national gold reserve; or a store of US dollars or euros….something that is stable and globally stable
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