Fiat Money

Why does fiat money work at all? Why doesn't it simply fall apart from its own illogic?

Since money is necessary for the the existence of any kind of complex division of labor society, and the state holds a monopoly on it,  I would say the reason it works is because using fiat money is better than the alternative - the end of civilization.

 It has worked so far, only due to a lot of fancy maneuvering and some dumb luck.  My guess is, however, that the Federal Reserves supply of luck is very close to running out.  It is only a matter of time until the catastrophic collapse of the fiat system.

I would say that the reason fiat money works is because it is subsidized. 

However, I believe that the main reason is because we are forced to pay taxes -- in the fiat currency.  

Hence, it happens to be easier to use the same fiat currency for other transactions. 

If the American People ever allow the banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children wake up homeless on the continent their fathers occupied. The issuing power of money should be taken from the bankers and restored to Congress and the people to whom it belongs. I sincerely believe the banking institutions having the issuing power of money are more dangerous to liberty than standing armies. - Thomas Jefferson

In addition to this danger to which Thomas Jefferson referred, existed his less than ambiguous position on the legality of our current system:

It is known that the very power now proposed as a means, was rejected as an end by the convention which formed the constitu- tion.

             - Thomas Jefferson (in a statement regarding The National Bank and The United States' providing it the power to issue our country's currency.)

because it's a product who's purpose is to hold value. It's like a universal contract agreement, and one that can fall through at anytime. The fed prints contract agreements, and sells them, so it's a document product.

If you want to know why paper money hasn't collapsed, I recommend that you stop looking at this from a point of view of one who is observing society.  Instead, look at this from a more individual level.  Why do you desire this paper money?  After all, you're knowledgable enough to know that it's nothing but a piece of paper, and that government edict cannot give it value.  So why do you continue to desire it?

You desire it because it is the primary medium of exchange used by society, and you wish to make exchanges with society.  This is the same reason other members of society also desire it.

And since the members of society desire it, there is demand, which produces a market value for the paper with which we trade.

The problem with paper money, therefore, isn't that it's "valueless," for it, like all commodities, is valued subjectively.  The problem with paper money is a combination of A) the fact that it's also similar to all other commodities in that the more there is of it, the less valuable we deem it as opposed to other things, and B) the fact that it is so easy for persons, groups, or governments to counterfiet it, thus causing inflation.

Paper money will not collapse unless we enter the state of inflation known as hyperinflation.  But even if it doesn't collapse, even if it does not reach the stage of hyperinflation, inflation is nevertheless a destructive thing, in that it is the theft of value from the paper commodity held by people, most of whom have earned it or aquired it without violating the non-aggression axiom.  It is, indeed, theft.

The Dollar is not entirely fiat.

The explanation that the dollar is held up by "faith in government" is only partly correct. Americans use the dollar because our Government tells us to, and we have faith that our Government will turn its guns against us if we don't.

 But this does not explain why foreign nations and multinational corporations, much more powerful than you or I, hold to the dollar; yet the Dollar is the international reserve currency.  Even though there is also a power disparity between the American Government and the governments of other countries it is not so great as to allow it to force its currency on the whole world without powerful allies. This begs the questions: Who are these allies and what do they gain?

The most important is OPEC. Like I said the dollar, though not backed by gold, is still internationally commodity backed. OPEC sells exclusively for the Dollar. After the collapse of Bretton Woods system the dollar switch from a gold coupon to an oil coupon. We are in the era of the Petro-Dollar.

 
If you need oil, you need dollars. Any oil importing country must be a dollar importing country. In this way America is the center of world trade, and in a position to also be the toll collector of world trade. In this 20th century iteration of triangle trade goods are exported to the US for Dollars, the Dollars are then brought to OPEC for Oil.

 
The American Navy rules the seas. For this reason, other important allies are the former naval powers: Japan and the UK. They are committed to maintaining the status quo of a friendly imperial power controlling the seas. Thus Tony Blair is explained.

Those benefited by the Petro-Dollar are the owners of the Federal Reserve, the owner of the Dollar.  Enlisted to this cause is the Military Industrial Complex, which defends the Dollar's status as an oil coupon, in exchange for some of those freshly printed coupons.

The Oil Tyrants that rule the OPEC nations are pivotal to the system, but stand to gain little directly; they could just as easily sell their oil for gold. So in addition to the threat of "Regime change" they are bought by bribes and favors: a carrot and a stick.

So the American tax payer and the Military Industrial Complex again come into play, Oil Tyrants get guns and wars courtesy of Uncle Sam. Saddam gets war against the Iranians. Iran gets guns to defend themselves from Saddam. The Saudis and Kuwaitis get war against Saddam and weapons against the Israelis.

 

Fiat money is valued because you assume people will value it tomorrow. This assumption make sense if fiat money is currently used as a mean of exchange.
Although tightly linked to fiat money and probably necessary for its initial emergence, central banking is distinct from fiat money. Any money is fiat. Even though commodity money cannot fall through a certain roof, most of its value comes from its use as money.

Another question would be, why our current inflationary fiat money system isn't replaced by better money. The reason is twofold, legal tender currency that prevent debt contract specified in other currencies to be enforced and the taxation system that taxes the stability of a currency against another as "profit".

 

I would like to take a different tack and argue that our money is not fiat money any longer.  True fiat money is that found in instances such as Republican France, where merchants refused to take money at face value and were guillotined.  I have only heard of one instance today where legal force was used to make someone accept money (and that was the bizarre instance of a college student trying to pay his tuition in $1 bills as a protest).  Instead, most people accept money because of what they expect to be able to buy with it.  In that sense, it is a commodity currency, although not a uniform one.

 So why does the government not remove legal backing?  Primarily because the act of doing so would probably destroy confidence in the currency.  Because the currency is backed by the government, it has real value and people need not be forced to accept it.

I beg to differ, the money is not really "backed" by the government; in fact, currently the dollar has value despite the U.S. government. If the U.S. government stopped "backing" the dollar, and decided to withdraw altogether from the money business (except from preventing counterfeiting) the value of the dollar would either completely collapse or rise enormously. I bet the later would happen since dollar is now accepted and recognized worldwide as money.

Webster:

So why does the government not remove legal backing?

I insist that one reason might be that the government would lose control over the value of the taxes they collect and the redistribution of wealth. 

 

Webster:

Primarily because the act of doing so would probably destroy confidence in the currency.  Because the currency is backed by the government, it has real value and people need not be forced to accept it.

That does not make sense. Confidence in the currency can not possibly be a problem because tax-payers can use a foreign currency or something else. 

There is nothing stopping people today from using a foreign currency or from using chunks of gold.  However, the government will force you to pay your taxes in legal tender.  

Charles Anthony:

Webster:

So why does the government not remove legal backing?

I insist that one reason might be that the government would lose control over the value of the taxes they collect and the redistribution of wealth.

 

 First of all, there is the mere politics of the situation--removing backing would be percieved as far too radical an action in the present political situation.  However, while the government guarantees the legal status of money, it does not, to my knowledge, control its value, and thus it does not control the value of taxes.

Charles Anthony:

Webster:

Primarily because the act of doing so would probably destroy confidence in the currency.  Because the currency is backed by the government, it has real value and people need not be forced to accept it.

That does not make sense. Confidence in the currency can not possibly be a problem because tax-payers can use a foreign currency or something else. 

There is nothing stopping people today from using a foreign currency or from using chunks of gold.  However, the government will force you to pay your taxes in legal tender.  

Look at the monetary situation in the 19th century after the regulations that forced the payment of tariffs in specie, while banknotes were the primary currency.  Contrary to what your position seems to me to suggest, currency circulated in no greater quantity because it was the only legal tender of the dominant form of taxation.  Also, the government is percieved as being responsible for economic wellbeing and a collapse of the currency would be percieved as a problem, thus leading to voting repurcussions for the party that caused the action.  Remember that the government is not a rational actor with respect to its collective power, but with respect to the individual members' power.  Yes, there is nothing preventing people from using a foreign currency, but our currency is percieved as being most convenient.  If expectations of its value collapsed, that perception of convenience would evaporate.

 Webster,

 Just to clarify: understandably, the government can not control the value of its currency in the strictest sense.  Can we agree the government can have a major influence to the degree that it can influence the value of the taxes it collects?  What I am suggesting is that strategically, for a government that wants to redistribute wealth, the power to inflate the currency is best harnessed if the government issues this "fiat" currency and threatens violence in the collection of taxes in that same currency.  

 With respect to your historical account, I can accept it but I think it would be wise to consider the context and leave it all in the past.  Today, more people are more educated than ever before and people have instantaneous access to information.  

I fail to see what education had to do with the issue.  My point was merely that requiring a certain currency for the payment of taxes when it is less convenient than other currencies for other transactions does not lead to the sole use of that currency.  Now, the situation is different because the fiat money is the most convenient form of currency, but if that convenience collapsed I suspect that the money would still fall out of circulation and would be used only for the payment of taxes.

 I do not quite understand why you claim that the primary objective of the government is to redistribute wealth--I think that it would be more accurate to say that the members of government are primarily concerned with maintaining their own power, in which case causing a financial collapse would be bad simply because it would probably eject them from office. But yes, I do agree that with printed currency and a central bank the government has much greater control over taxation.

Webster:

I fail to see what education had to do with the issue.

-- because education, among other things, will influence a person's perception.

You used a historical account and said:

Webster:

Also, the government is percieved as being responsible for economic wellbeing and a collapse of the currency would be percieved as a problem,

To put it crassly, if people were stupid in the 19th century and people were smart in the 21st century, your historical account is comparing apples and oranges in a vegetable soup.  That is why I am saying that the history should be left in the past.  I am actually a little surprised that I have to spell this out in an Austrian discussion forum.  My understanding is that Mises firmly insisted that historical data is unacceptable economic evidence and the whole basis of the school of thought is praxeology.  

 

Webster:

Now, the situation is different because the fiat money is the most convenient form of currency, but if that convenience collapsed I suspect that the money would still fall out of circulation and would be used only for the payment of taxes.

That seems to support my point: the "fiat" currency only exists because people are forced to pay taxes in its form. 

 

Webster:

I do not quite understand why you claim that the primary objective of the government is to redistribute wealth--

Call it just my cynical editorial injection. I believe the sole of objective of government agents is to redistribute wealth: from the tax-payer to the tax-collector.  What governments do with the money is different issue -- to me it is irrelevent.