Saturday, 11 July 2009

Money from nothing?

Over at ThinkMarkets Gene Callahan writes
Again and again, I run across this complaint that fiat money “is money created out of nothing.” This is supposed to be an argument against fiat money, but, in fact, I take it to be a substitution of sloganeering for scientific analysis.
He continues,
I believe that fiat money is created from a government’s ability to collect taxes, combined with the fact that it promises to accept the pieces of paper in payment for those taxes. My hypothesis, as this point only a suspicion, is that the “backing” of fiat money is first and foremost its ability to pay tax obligations to the government, and that’s its value for other uses is anchored in this ability, just as the value of gold as money is initially anchored in its value in all non-monetary uses.
I would think that the fact that the government is willing to take money as payment for taxes provides a reason for everybody else accepting it. Think of a situation where there were more than one supplier of money, say each private bank offered its own notes and coins. But the government would only accept one of these currencies for the purpose of paying taxes. Which currency do you think would quickly become the median of exchange?

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