Thoughts on the “Value” of Fiat Money

I generally liked this post by Joe Weisenthal on Bitcoin and the value of fiat money.  In particular, I like these points:

“But fiat currencies have tremendous intrinsic value because governments say they do. That’s why they’re called fiat currencies. They have value by government fiat.

This truth might be annoying, but the fact of the matter is that we live in a world of laws, where governments have armies, and can imprison you if you don’t pay taxes. And every transaction that you do is taxed in some way, meaning that to operate in any practical matter in this world means transacting in US dollars.

So the US dollar isn’t just important because other people think it is. The US dollar is important, because the world’s strongest entity, with the full force of the US army, the FBI, the CIA, the NSA, and various local authorities with guns demands that you pay them in US dollars. That’s not faith. That’s the law. Sorry.

Even outside of the requirement to pay taxes in US dollars, the Federal Reserve system has established the dollar as the unit of currency for banking in the United States. So if you want to be plugged into the banking system at all — which is a requirement for virtually all individuals — you have to use US dollars.

So instantly, anyone who says the US dollar is backed by “faith” or an “illusion” has no concept of the sheer force behind the currency.

This isn’t true of Bitcoins at all.”

I think that’s pretty good.  But I think Joe’s description misses an important point.  Money doesn’t just have value because a government says it has value.  After all, that money just serves as a means to an end.  Saying that a US Dollar has intrinsic value just because the government says it has value is like saying that a theater ticket has value because a theater company declares it as the thing that gains you entry into a show.  But this misses the point.  The ticket to enter the show is just a means to an end.  The real value is not in the ticket, but in the show itself.  If the show is terrible no one will want your tickets even if you have an army that can attempt to force people to use your tickets.

The same can be said of the US economy.  If the output of the US economy is not worthy of demand then the Dollar will have no value.  Bitcoin has value in that it achieves the same thing the US dollar does – it gives someone access to goods and services.  And its users attribute some value to it because it skirts the costs of transacting with bank deposits (like taxes and other associated costs).  But the problem with Bitcoin (as I described here) is that it has an intrinsically low level of trust (because it is unregulated – yes, that court system and regulated monetary system most certainly does embed a certain level of trust in the money system) and does not give you access to the majority of the show that is the US economy.  In other words, unlike bank deposits, Bitcoin isn’t a very good medium of exchange in that it doesn’t serve money’s primary purpose all that well.  Not having access to all that output is a big problem for any kind of money.  But there must be valuable and high quality output in the first place.

I think it’s important not to put the cart before the horse when discussing these matters.  Output necessarily precedes taxation and government power.  That’s why I put output at the top of my hiearchy of fiat money viability (see here).  Miss the emphasis there and you’ll completely misunderstand the purpose of money in the first place.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  1. “If the show is terrible no one will want your tickets even if you have an army that can attempt to force people to use your tickets.

    The same can be said of the US economy. If the output of the US economy is not worthy of demand then the Dollar will have no value. ”

    is that really true though? as long as the gov’t locks people up for failure to pay taxes in USD, then people (those people who want to avoid jail, at least!) will be forced to value the USD, won’t they? regardless of their view on the worthiness of the output of the U.S. economy.


      • This is also why black market currency generally develops in corrupted economies. When the output goes and the government tries to prop up the money the black market develops in a cheaper version of that same money. It’s mostly about output. Not government powers.

        • Actually LVG, I think it is the opposite (at least from Iraq).
          Iraq is an interesting take on this concept. I have invested a lot over the years in Iraq and know that during the Saddam regime the Swiss Plate made dinars were not legal tender after the Gulf War but actually became more a store of value to the people because the limited supply and quality:

          “After the Gulf War, the Iraqi government disendorsed the old currency, favoring newly printed Saddam dinars, and the Swiss dinar ceased to be legal tender. However, the old currency still circulated in the politically isolated Kurdish regions of Iraq. The government of the Kurdish region did not have the printing plates of the Swiss Dinar, but it also refused to accept lower-quality Saddam notes (which were issued in huge amounts). Since the supply of Saddam notes increased while the supply of Swiss dinar notes remained stagnant (even decreased because of torn notes), the Swiss dinar appreciated against the Saddam note. By having its own stable currency, the northern part of Iraq effectively evaded inflation,
          whi ran rampant throughout the rest of the nation:

        • Well, I am a real stickler on this point because too many economists look at the USA and just start regurgitating some “American exceptionalism” argument in some form. It’s easy to look at a high output developed country and just start talking about how “wealthy” that country is and how it can “afford” this and that. As someone noted below, look at a lesser developed region of the world like South America and you see very different dynamics occurring. Plenty of South American dictators have had more power than anyone could dream of and rule over weak and pathetic money systems that are incredibly fragile (mainly because they don’t produce anything of real value).

      • i posted this explanation to /r/bitcoin yesterday, which i think is a decent illustration:

        imagine a farmer with ten cows, a barn, and some seed on January 1. these are all he has, but it has a estimated net worth of $100.

        he spends the year sowing the seeds, pulling weeds, waiting for rain, rejoicing when it rains, harvesting his crop; he grazes his cattle, breeds them, three calves are born, kills one to eat.

        on December 31, he has twelve cows, a (slightly worn) barn, some seed and some surplus crop that he plans to eat during the next year. he hasn’t sold a thing and doesn’t care for money.

        but he needs dollars.

        he needs them because the tax man is coming. there are two more cows now than there were, plus the surplus crop that wasn’t taken for seed. those things are worth something in real terms, and the difference in his net worth between the start and end of the year represents his income. the tax man evaluates his December 31 net worth to be $120.

        our farmer owes tax on his $20 of income, which at 15% is $3. so he is compelled to go to market, sell some of his surplus crop for $3, and hand the money over to the tax man.

        that guaranteed demand, the aggregated economic exchanges of real goods for dollars needed to pay tax is how the real value of the dollar is determined.

        and the tax man will never, never, ever ask for bitcoins.

        • If he hasn’t produced anything he hasn’t generated a tax bill. I think Cullen’s point is proven by your example. Output precedes taxes so taxes can’t be the main reason why we use money.

          And, if he’d bought his farm with something other than dollars (like Bitcoin) the government would have no record of his ownership and would not tax him anyway. I think this is one reason why people are using Bitcoin.

          • right, it’s the real output of the economy that taxes are taken from.

            but taxes are mandated to be taken in dollars — you can’t give the tax man your excess crop. so you must have dollars, and that guaranteed demand creates the value of the dollar.

            output precedes tax, but tax precedes the dollar.

            i do agree — many of the bitcoiners i’ve talked to are essentially tax evaders. if bitcoin were to become significant in some way, it’s a mortal lock the IRS would move in to destroy it.

            • “that guaranteed demand creates the value of the dollar.”

              I think you have to be more specific on “value”. As I described to KB the state can determine what MR calls “acceptance value”. It can determine that bank deposits, for instance, are the primary form of money that are used in the US banking system (that most people pay their taxes with). It also determines that the USD is the unit of account. But the state cannot determine what MR calls “quantity value”. Quantity value is purchasing power, foreign exchange value, production value.

              I’d say the importance of quantity value far outweighs acceptance value so when we’re talking about what gives money its “value” we should make a clear distinction there. Taxes don’t drive money more than output drives money. They can’t or quantity value would not matter nearly as much as it does.

              • The quantity value and acceptance value point is one of my favorite contributions from MR.

              • that’s well said, Cullen — the acceptance value is the legal standing, the acceptance value is the manner of determining the actual value of the unit relative to goods and services.

    • Without the valuable output they’ll value those USDs for a lot less than government would probably want. See Latin America where inflation is very high in many countries because there’s an aggregate supply/demand imbalance. Those countries don’t actually produce anything valuable, but they create money generating demand for it like crazy.

        • Yes, you’ve pointed that out a number of times over the years. I can’t remember the post, but you had a comment in one about boob jobs and whether they were good at certain times. :-)

        • I think you are wrong in the following sense – you had too much demand based on credit expansion, which looked for a long time like the normal & sustainable level, which invoked too much supply. Now that demand has snapped back to a truer sustainable level, you say you have a demand problem. You have an oversupply problem actually.

          • Agreed.
            I have a ‘demand’ for a new car, and Ford has the capacity to ‘supply’ me a new but I do not have the resources to pay for a new car. Now I could go out and borrow money for the car, or take out the equity of my house, but those are short-term solutions for me and the economy, too.
            Unless I can grow my income, then borrowing doesn’t work.
            Lower interest rates don’t work, asset inflation doesn’t work, deficit spending and bond issuance doesn’t work … because none of those things generate income or spur production.

    • A bad theater company could hire a bunch of thugs to make people use their tickets and see their shows. That doesn’t mean anyone else will believe the tickets are valuable.

      • Indeed… But if “the show” has gotten so bad and is the only “show” in town, people will do anything to get out – look at the mass exodus out of Greece, Spain etc – anyone with a half-decent education is of to a different “show” in some other part of the world…

    • All international transactions are denominated by USD (reserve currency). That’s why US strongly oppose any bilateral trade without using USD. Direct trade of RMB with Aussie dollar is a blow to USD status. USD is different from any other currencies. That’s probably why there is “American exceptionalism”. Paper money is really paper. Without a rule of law, it’s just paper.

  2. Fiat currencies have value if trade is internal to its political / economic hinterland.
    Otherwise these systems must game the system or indeed go to war.

    Its becoming obvious now that the US & UKs currency have maintained their value only through euro austerity.

    Any look at UK trade in real goods (not services which recycle this wealth) makes this very clear.

    Europe is in many cases the modern UKs trade surplus India – the jewel in the crown.
    £106 billion UK trade deficit or nearly 7% of GDP is simply fantastic.

    The strange dynamics of fiat currencies with imploding real NET production vs hard currency unions is little understood me thinks.

  3. Cullen, on this point I think your view is overstated and your logic flawed. “If the output of the US economy is not worthy of demand then the Dollar will have no value.” There is a very real and clear demand to not go to jail. As long as the government is valid, there is demand for whatever it demands in exchange for staying out of jail. Certainly a currency that has little value in exchange for real output (food, shelter, …) creates a political crisis of confidence in the government, and hence the government’s ability to effectively jail people. This is partially what we have seen in the cases of hyperinflation, the ability of the government to govern is greatly diminished. But as long as there is not effective anarchy, there is value in whatever unit of currency a government requires to stay out of jail.

    • Sorry, but no one wakes up in the morning and says “I’m going to use this money because I want to pay taxes and stay out of jail”.

      A child sees value in a dollar bill. Not because they understand what jail is (they don’t), but because they know it means they can obtain something with it. The govt deems the unit of account and determines the banks as the issuers of the money we all chase. This all has much less to do with taxes and jail than it does with the laws determining what money is (in our case, bank deposits) and having access to output by having access to that payments system.

      • “Sorry, but no one wakes up in the morning and says “I’m going to use this money because I want to pay taxes and stay out of jail”

        Actually Cullen, In Iraq post Gulf war, there were 2 main currencies Old Swiss Plate made notes made in the UK and imported, they were the pre gulf legal tender then afterwards the Iraqi govt disendorsed them and started printing their own Dinars that were cheaper quality.
        You could effectively hide the more valuable swiss notes for black mkt activity and use the “New” Dinar notes for “Official” transactions.

        • I also like this quote in the link:

          “In the jargon of economists, the value of a dollar is a result of “network effects.” Just as a fax machine is valuable to you only if lots of other people you correspond with also have fax machines, a currency is valuable to you only if a lot of people you transact with are willing to accept it as payment.”

          I think this “network effect” plays a much larger role in the acceptance of money than taxes.

  4. “The US dollar is important, because the world’s strongest entity, with the full force of the US army, the FBI, the CIA, the NSA, and various local authorities with guns demands that you pay them in US dollars. That’s not faith. That’s the law. Sorry.”

    Excuse me, what? Joe is an idiot. I don’t have to pay for ANYTHING with US dollars if I transact with a seller willing to accept an alternative such as
    - goods in kind
    - services
    - other currency
    - silver/gold
    - etc.

    Guess what happens when I do this? The government cannot capture the transaction and tax it, period. Considering how the dollar’s value has deteriorated for the past 50 years and is now being systemically destroyed by an unrestrained Federal Reserve, I think ANY alternative to the dollar is more valuable right now. Perhaps Bitcoin (full disclosure: I own none) is still a nascent currency, but the fact it exists at ALL tells me all I need to know about the dollar.

  5. JOE IS WRONG: Bitcoin is endowed with encryption- a gift from the creator. Does gold back bitcoin? No. Does a government back bitcoin? NO. YOU BACK BITCOIN BECAUSE YOU HAVE INTRINSIC VALUE. If you’re an investor, then, prob bitcoin is not for you. Use bitcoin to trade with like minded people. It WILL store value with them, because they believe in it. understand psychology first, then define money. Modern econ seems to forget that they are missing a big piece of the equation. Psychology is not some unknowable soft science. It is the one science the sheep or the 1% cannot handle . Look in the mirror and sheer away!

  6. Sometimes I think MR and MMT are in essence saying the exact same things, but just putting different emphasis on different aspects.

    For example, MMT emphasizes the importance of the law through the enforcement of taxes, but MR retorts that taxes don’t mean jack without the underlying production. I don’t know if MMTers has made the following retort, but are there any examples of the underlying production of an economy being robust without a state enforced currency? (state here meaning any type of centralized authority)

    If not, then it seems that “putting the cart before the horse” is a poor idiom because neither taxes nor underlying production is the cart or the horse. Neither of them is more importnat. Rather, they are complimentary; each needs the other. Maybe a better phrase is “opposites sides of the same coin”

    I’m thinking that in order to MR to claim that underlying production is more important than state enforcement (taxes), then MR-ists need to be able to show that robust production has occurred without a currency enforced by a central authority. Otherwise, there is no cart and there is no horse. There is a coin.

    • Output IS the coin. Without it, there can be no taxes so resources MUST precede taxation. Saying “taxes drive money” ignores the fact that output necessarily precedes taxation. This should just be obvious.

      A money system can definitely exist without taxes. Bitcoin proves it and so does the Iraqi Dinar story that Cowpoke noted. This shouldn’t even be controversial in my opinion, but MMT distorts modern examples of money to imply that just because most modern money is attached to a govt then all money is a creature of the state. I known laws are important to a healthy form of money, but they’re not a necessary component.

      Of course, MMT can’t even define the word “money” and actually refuses to use the term so the whole MMT premise is vague to begin with.

  7. Fiat money is a claim on current AND future production. If private banks create money just look at the composition and duration of their loans … for fixed private investment (ex-residential) and R&D. The duration of these investments is 5-10 years. That`s the other problem with Bitcoin … there`s no future. BTW taxes are not enough to justify fiat; if there is no future, the NPV of taxes go to zero.

  8. Cullen, I can’t quite catch your meaning in this sentence: “And its users attribute some value to it because it skirts the costs of transacting with bank deposits (like taxes and other associated costs).” Would you kindly briefly expand on that idea, please?

  9. Sorry Cullen, but I think Joe is more correct on this subject. First, imagine tomorrow the US government says the new dollar value would be the old value times X, whether it is by exchange, dilution, or deposit cancellation. What do you think would happen to “value” of dollar? And mind it, the country output would not change.

    Secondly, talking about output. Looking at Weimar, at many point during their hyperinflation cycle, their output grew strongly. Yet “value” of their fiat got destroyed anyway during the same time periods. Actually, there is strong point of view that strong output growth was the result of fiat destruction.

    The government is the key element of fiat stability and “value”.

    • You’re making the American exceptionalism argument in some form. Either way, I disagree. The state can determine what MR calls “acceptance value”. It can determine that bank deposits, for instance, are the primary form of money that are used in the US banking system. It also determines that the USD is the unit of account. But the state cannot determine what MR calls “quantity value”. Quantity value is purchasing power, foreign exchange value, production value. I don’t know which type of value you think is more important, but I certainly do. HINT: It’s not the one controlled by the govt. :-)

      • Yes and no. I agree that the market determines purchasing power of fiat. Yet it happens within the frame, both juridical and monetarist, set by the government. The government can create both deflation and inflation/hyperinflation. The market will have to set the purchasing power within the situation the government created. All “money creation” by the banking system is based on what government allows to do. If tomorrow it makes the law that only the saving deposits may be loaned out (as some people propose), all the elaborate concept of money creation by MR would go into non-existence. Just one simple law. Alas, but that is the case – fiat is the government creature.

        Gold, for example, is different creature and the government does not have that type of power over it.

        • Well, of course, if we changed the laws and the govt said banks couldn’t do this or that then that would change our reality. I didn’t name it Monetary REALISM because I was describing some alternate universe. You’re describing an alternate universe to justify your thinking. In today’s REAL monetary system the banks control the money supply and the govt has outsourced the power to them. The govt could change that, but so what? I won’t change the model I work with until that happens. And until then, the govt has very little control over the actual money supply and financial assets in a grand scheme of things. We live in a money system dominated by the private sector and controlled by the private sector.

          • True. Yet then your theory would describe just one narrow band of possibilities where fiat can exist. And every time the government changes some specific laws you would have to rewrite it.

            The reality is the government controls the ultimate power over fiat. Here, we can claim the society controls the government, or even private sector/banking cartel controls the government. I do not want to delve in these speculations.

            Just remember Roosevelt. It is how easily the government was able to change something really fundamental in that past monetary system.

            • Hey, if you want to go around thinking the govt controls the bankers then be my guest. Just remember that our “government” is a private sector creation and not some monarchy or authoritarian establishment. And it’s ruled by people who vote in the private sector. And the people who most influence those votes are special interests. And when the bankers want something to get done so it benefits them they give money to the special interests (and bankers just so happen to have a hell of a lot of money/influence/power). So yeah, our government controls the bankers. And by “government”, you mean the bankers control the bankers. Anyone who doesn’t realize this is sleepwalking through our reality. Just see how pathetic Dodd/Frank was for proof.

              • In addition to explaining to people how the institutional design of the monetary system works, maybe you should start explaining how the institutional design of our political system works as well. I think a lot of people assume the government can do a lot more than it really can.

                • Interesting question there on the ‘reality’ of who is in charge.
                  I agree the bankers control the government and the money supply. However, the government has the power and the authority to control the banks if they were willing to use the power. Is that right?
                  We could have another Roosevelt, as KB suggests, or a Nixon changing the rules regarding gold or an Andrew Jackson taking down the central bank.
                  So under a more activist government, would the rules of MR change?

                  • “the government has the power and the authority to control the banks if they were willing to use the power. Is that right?”


                    “So under a more activist government, would the rules of MR change?”

                    If, for instance, the govt consolidated the Fed into Tsy and nationalized the banking system the MR paradigm would turn into something that basically looks like MMT. We’d then have truly state money.

              • Please, let’s not move the focus of our discussion, and resort to government-related rants. I completely agree with you here. Yet, still, it is the government who holds the ultimate power over fiat. it can work in perfect alignment with the banks up to a certain point, but then, for whatever reason, it can change very fundamental rules of the monetary system.

                Again, I am referring you to Roosevelt. This example is very important, as it really relates to us. Actually, in that regard, Nixon and Bretton-Woods would also be good examples. The system(s) exist for many decades, seemingly unshakeable, and then, in a matter of days, they are changed inside out.

                • All of these seismic shifts have been done with one underlying consistency, however – private banks rule the money system. Bretton Woods didn’t change that, the Fed Act of 1913 didn’t change that, Roosevelt certainly didn’t change that. In fact, FDR’s cousin Teddy was a great example of how a bully politician fails to conquer the banking beast.

                  Personally, I think it’s pie in the sky to go around claiming that we’re just going to crush one of the most influential and powerful industries in history “in a matter of days”. We just went through the biggest financial crisis in the history of the USA and nothing changed in banking. Dodd Frank is smoke and mirrors. I appreciate your optimism in govt, but I think it’s misplaced here. The banks are their own governors when it comes to setting the rules for how money distribution and banking works. Anyone who claims the govt rules the bankers is blind to our reality.

                  • Actually, I 100% agree with your thesis here.

                    The big question though is – what would be the next big fundamental change the bank cartel would push on the US government and, thus, on the world monetary system.

                    I assume you assume the current system would be kept in the current state (as described in MR) for very long time. Myself, I am not so sure. I think it will be changed again within reasonable time frame – 3-10 years.

                    The problem is, I, unfortunately, do not know which way it would turn. As a practitioner, you would agree that knowing such things can make you money. Just imagine somebody knew what Nixon was planning to do….

  10. What the USA and the dollar economy ‘supplies’ is a secure place for people to live and pursue happiness(which includes business for some). The safe-haven effect is most recently evident in Asian money flow into the west coast. Libertarian(read tax-free) utopias like the Cayman islands exist because of the inefficiencies in the system (which is inevitable in any human/political system). Bitcoins may ‘supply’ and intellectual need but till it becomes the official US currency, it cannot supply the other human needs.

  11. It seems to me that bitcoin users must also have faith that their system is more powerful than any government.

    Good luck with that.

  12. Braetton Woods & world reserve status is NOT the basis for US dollars value –A currency’s value is given value because taxes have to be paid in that currency AND it is based on
    backed by the production of what the currency can buy, just like gift cards & gift certificates value are based on what the business issuing them produces or sells

    That’s why Walmart & Best Buy currency aka as gift cards/gift certificates has the highest value on Ebay vs. some small business that produces things few people want.

    The US dollar has value because it actually is still the LARGEST country exporter of food & manufacturer of goods (from Intel chips, Microsoft Windows/Office, to Hollywood movies/music) that the world wants & NEEDs

    –China depends on the US for imports of wheat, soybean, rice, corn. See charts below –btw, Russia & China stopped using the US dollar for trade between them.. the US dollar didn’t lose/drop in value nor collapse nor hyperinflate

    why US fiat dollar (and even EURO) has value, backed by world’s greatest production/export of food:

    The US doens’t need nor needed Braetton Woods’ Accord to be ‘world reserve’ currency… that’s just a formality that happened after the fact because the US for years prior was the world’s greatest exporter
    producer of goods and still the leading nation as biggest exporter of FOOD after WW2 (making the US dollar most valuable),
    then world’s biggest importer (by ‘exporting’ fiat US dollars as nations exoprted to the US to accumulate US dollars because they wanted US dollars to buy US goods/services) which is how it became ‘world reserve’ currency.

    • Reserve currency status is a function of output and demand for output. Just like taxes are a function of having output that can be taxed. It is illogical to argue that taxes are the foundation for a currency’s value when it is the very output that make taxes possible in the first place.

      • You mention output is at the top of your hierarchy, but is trust not higher? Is it not trust that makes the exchange of goods and services that much more efficient?

  13. Cullen – you said: “…But the problem with Bitcoin is that it has an intrinsically low level of trust (because it is unregulated – yes, that court system and regulated monetary system most certainly does embed a certain level of trust in the money system) and does not give you access to the majority of the show that is the US economy…” You cannot underestimate the critical importance trust plays in every fabric of our society, more so than economic output or laws. If China were to overtake the US in terms of economic output, would the yuan necessarily take the place of the dollar as the reserve currency of the world? I say trust needs to be at the top of everyone’s hierarchy. In some ways, I think the idea of American exceptionalism is closely linked to the notion of trust – at least for the moment, since trust in US institutions has been falling for some time now.

  14. Bitcoin’s point is that economics as a science is incomplete without an understanding of politics. We dont really have “political economy” in universities nowadays (we have political science and economics), but this relationship was understood to be crucial for Classical political economists (Smith, Ricardo, etc.) and Marx. Right up to the marginalists, basically.

    What I find interesting about this blog are the frequent struggles to define money, in particular in relation to the concept of value. One thing that has not been mentioned, though it may be worth a fresh read for some of you, is Marx’s argument that money is an abstraction in capitalist systems. This abstract concept reflects money’s role as a store of value, a medium of exchange, and other apparent social functions. But behind its appearance is its essence. It reflects something that cannot be seen or understood except as a further abstraction itself: the social relations of capitalist production (CR uses the term “output”; fine). Of course the social relations of capitalist production is not something economists want to discuss, because they prefer to presume a free market for (wage) labor. But the creation and maintenance of this market for wage (for Marx, exploitable) labor is where the rubber hits the road. That is, the politics comes pouring back into the “science” of economics. Hence Bitcoin’s reference to the threat of state force/violence.

    • I congratulated Scott Sumner here for not telling people not to trust Monetary Realists:

      “Don’t trust the media. Don’t trust the old monetarists, the new and old Keynesians, the RBCers, the Austrians, the MMTers, or the new classicals. Only the market monetarists offer a model that allows you to make sense of what’s going on in the world.” — S. Sumner

      Notice he didn’t badmouth Marxists either! Ha! ;)